Bond Bubble Hasn't Burst

by: Ron Rowland

It seems as if everyone wants to label something a "bubble" these days. There is a bubble in bubbles. Interest rates have been falling for 32 years now. As rates fall, bond prices rise and vice versa. It has been a multi-decade bull market for bonds. Unlike stocks, which have no upper price limit, bond prices are theoretically limited on the upside as a function of interest rates and maturity dates. Once bonds mature, any remaining price premium will disappear. With these relationships intact, it is no surprise that predictions of the bond market's imminent collapse began to appear as interest rates fell to historic lows in 2008.

The "bond bubble" is now well into its fifth year. Investors heeding the warnings of bond market fear-mongers missed an opportunity for substantial gains. The iShares Barclays Aggregate Bond ETF (NYSEARCA:AGG) generated a cumulative total return of more than 23% since the end of 2008. Shorting bonds since the bubble first appeared has been a losing proposition.

You might be asking how this is possible if interest rates reached historic lows in 2008. The answer is simple -- interest rates have continued to trend downward. For any given market, a "historic" level is not an absolute limit. The 10-year Treasury yield fell to nearly 2.0% that year, a level last reached in the 1940s and previously never seen by most investors alive today. Furthermore, the decline did not stop there. Today, the 10-year Treasury yields just 1.7%.

Can yields go lower still? Of course they can. Germany's 10-year yield is 1.3% and Japan's is only 0.6%. The secular decline in U.S. interest rates will eventually end. It could happen this week, or it could happen years from now. The bubble may burst, or it may slowly deflate. Accurately forecasting the future is an uncertain endeavor. There is an exception, though -- anyone buying a 10-year U.S. Treasury today will receive an annualized return of 1.7% (before inflation and taxes) if held to maturity in 2023.

Disclosure: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.