Don't Let Talk of a Bubble Scare You Out of Bonds

Includes: IEF, TBT, TLO, TLT, VGLT
by: Cullen Roche

It’s becoming increasingly popular to describe the U.S. government bond market as a “bubble”. As I’ve previously explained, this strikes me as totally nonsensical for several reasons – the primary reason being that the term simply is not applicable to an asset in which you receive your entire principal back at maturity.

The term “bubble” implies a grossly mispriced asset that is susceptible to substantial losses. If the instrument is used as intended there should be little to no risk of principal loss in a U.S. government bond. And given the weak economy and constant need for government intervention it is no surprise that investors are seeking a safe haven such as bonds.

Aside from all that, Credit Suisse recently published an interesting piece of research arguing the same point – that the U.S. bond market is not a bubble. They noted that the price action in government bonds is very different from historical bubbles:

We note that the price action of bonds it is very different from the bubbles in other asset classes we have seen over the last 30 years. The six-month US bond return is 1.9 standard deviations above norm, compared to an average of 5.9 standard deviations during previous bubbles.

So you can see the price action is not even remotely similar to the great bubbles in history. If investors continue to use government bonds as they are intended (for instance, don’t make a 10 year loan with the intention of demanding your money back in 10 minutes), diversify across bond markets and generally allocate bonds as they are intended (as a hedge against other higher risk assets) then there should be very little risk of you ever experiencing a catastrophic loss such as those seen after many of the great bubbles of the last 30 years.