Bond Bubble Coming to an End? Prepare for the Bust

Numerous bloggers and analysts have declared that the latest bubble seems to be occurring in the bond market. There could be some truth to that opinion. Take a look at the following chart (click to enlarge) of the iShares 20+ year Treasury Bond Fund ETF (TLT):

This is definitely looking bubbly. The yield on the 30-year bond has now fallen to 3.2%, the lowest on record going back to 1977. This is unprecedented.

When this bubble bursts, the individual investor now has the tools to benefit. ProShares offers an ETF just for this purpose, the UltraShort Lehman 20+ Year Treasury (TBT). The chart (click to enlarge) is presented below:


The ProShares ETF has been available only since May of 2008 but it looks like the timing is perfect. Investors have not been afraid to trade this ETF, with volume today, for example, running over 2 million shares. The ETF has plunged as TLT has rocketed upward and gets cheaper by the day.

Right now, bonds are benefiting from the flight to quality trade. Each time another shoe drops in the stock market, bonds get bid up even further. In addition, Ben Bernanke has suggested more rate cuts are in the offing and that the Fed may at some point actually begin buying long dated bonds in the open market. This has created a very bond-friendly environment.

On the other hand, bonds will eventually be subject to price pressure when supply drastically increases as the government works to pay for the various bailout and stimulus actions being taken to fight the current economic downturn. The current abnormally low yield can be expected to revert to its mean. At some point, stocks will bottom and the flight to quality will reverse, reducing demand for bonds. As these events play out, the bond bubble will burst.

Conclusion --

It seems that we aren't too far away from our next bubble-busting event, this time in the bond market. It would be worthwhile for investors to keep a close eye on both of these ETFs and perhaps consider building a position in the ProShares UltraShort ETF. When TLT begins to crumble, it's liable to go quickly.

Disclosure: None

Comments

[Steven Hansen:]

the fed is buying the t-bills effectively eliminating the debt. the more debt produced, the more t-bills they will buy. everyone should just relax and watch our government at work.

2008 Dec 03 05:38 AM

[dfx:]

don't be fooled by charts. this is the age of crazy VIX and herds of angry black swans. QE simplified = the fed is buying its own debt.

2008 Dec 03 08:16 AM

[Gaucho:]

Government buying its own debt?

What the hell does that mean? I guess we could run a hundred trillion dollar debt and it will be all right since the government will be buying it.

I think that you are either talking about digital printing of money or taking on a huge amount of debt service paid buy you and me.

I believe that the author is correct we have reached an inflection point. The foreigners are not able and unwilling to buy more debt. This will not have a happy ending for the owners of this debt. I have hear estimate government is taking on a liabilities as high as 9 trillion or more. This is third world country actions and even the dollar and the US bonds will break under this pressure.

2008 Dec 03 12:45 PM

[carey_jim:]

I wonder if ProShares itself is going to be the next bubble?

(Maybe the company should issue a stock for itself so we could trade IT publicly instead of just circulating rumors about the operations of its many ETFs.)

2008 Dec 03 04:45 PM

[Patrick Lau...:]

The Federal Reserve is not a government agency.

2008 Dec 03 08:58 PM

[cyclingscholar:]

I understand the point of this article and am, in fact, in on this trade at this very moment. (that squeaking you hear is me). I also agree that bonds or overpriced as the fear factor, in my opinion, should and HAS tempered a bit. And yea yea yea there is all that debt and all that money out there.

But it is incumbent on a trader to look at possible errors in his (my) thinking. If the velocity of money worldwide is collapsing---a fancy word for severe recession, for those of you who haven;'t taken economics 101---and we have deflation or zero inflation ahead, than the 3.5% on US government bonds is a real 3.5% return...and thats not too shabby for such high quality paper.

Still...these buyers actually believe inflation will average zero for the next thirty years? ;)

cyclingscholar

2008 Dec 04 10:42 AM