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Kirk Lindstrom has an engineering degree from the University of California, Berkeley. Following 20 years of research and development as a scientist and engineer at Hewlett Packard, Kirk turned his attention to investments where he edits "Kirk Lindstrom's Investment Letter," that... More
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  • Bond Bubble Warning from Jeremys Siegel and Schwartz 3 comments
    Aug 18, 2010 2:26 PM | about stocks: TIP
    Jeremy Siegel and Jeremy Schwartz Say Bonds Are In A Bubble

    Jeremy Siegel (author of Stocks for the Long Run") was just on CNBC to say bonds are in a bubble and stocks are a better deal.  In an op-ed written at the "Wall Street Journal," Jeremy Siegel and Jeremy Schwartz say that bonds, and in particular Treasury bonds are extremely overpriced, similar to what the tech bubble experienced in the late 1990's.

    A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds. Investors, disenchanted with the stock market, have been pouring money into bond funds, and Treasury bonds have been among their favorites. The Investment Company Institute reports that from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen a massive $559 billion of inflows.

    We believe what is happening today is the flip side of what happened in 2000. Just as investors were too enthusiastic then about the growth prospects in the economy, many investors today are far too pessimistic.

    The warning is not just for regular bonds but also TIPS.  (See chart of TIPS rates below article)
    The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS - More Info) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout.

    Shorter-term Treasury bonds are yielding even less. The interest rate on standard noninflation-adjusted Treasury bonds due in four years has fallen to 1%, or 100 times its payout. Inflation-adjusted bonds for the next four years have a negative real yield. This means that the purchasing power of this investment will fall, even if all coupons paid on the bond are reinvested. To boot, investors must pay taxes at the highest marginal tax rate every year on the inflationary increase in the principal on inflation-protected bonds—even though that increase is not received as cash and will not be paid until the bond reaches maturity.

    Jeremys Siegel and Schwartz recommend stocks for both income and inflation protection
    From our perspective, the safest bet for investors looking for income and inflation protection may not be bonds. Rather, stocks, particularly stocks paying high dividends, may offer investors a more attractive income and inflation protection than bonds over the coming decade.
    and
    Due to economic growth the dividends from stocks, in contrast with coupons from bonds, historically have increased more than the rate of inflation. The average dividend income from a portfolio of S&P 500 Index stocks grew at a rate of 5% per year since the index's inception in 1957, fully one percentage point ahead of inflation over the period. That growth rate includes the disastrous dividend reductions that occurred in 2009, the worst year for dividend cuts by far since the Great Depression.
    What many bond investors fleeing the risk of equities fail to see is the risk of rising rates on bond funds.  The article points out the risk:
    If 10-year interest rates, which are now 2.8%, rise to 4% as they did last spring, bondholders will suffer a capital loss more than three times the current yield.
    [3 x 2.8% = 8.4%]
    What I own: In addition to equities, I am currently long TIPS, TIPS funds VIPSX (charts and quote) and FINPX (chart and quote) and Series-I Bonds (the majority have a 3.0% base rate) in my personal account.    I-Bonds will not lose net asset value if rates surge but new i-bonds currently pay very little above inflation so I have most of my cash in CDs and savings accounts paying over 1.0%.  I personally own no bonds or bond funds not indexed to inflation.   I also own a REIT fund.  REITs pay good income and should do well in a growing economy but they could suffer if we have a double dip recession.

    In  both the "core" and "explore" portfolio in  "Kirk Lindstrom's Investment Letter" I sold all bonds not indexed to inflation with the majority of my fixed income (about 30% of the total) in cash and CDs.  For yield and diversification, I have a REIT fund in the "Core Portfolio" in  "Kirk Lindstrom's Investment Letter" that has done well the past two years and should continue to do well if the economy avoids a double dip recession.

    For the Future:  I am strongly considering selling my TIPS funds to lock in nice gains and perhaps wait for them to pay a better spread similar to when I bought them.  The individual TIPS I bought pay inflation plus better than 1.0% so I can hold those to maturity and do very well with or without inflation.

    Chart showing 5-YR TIPS rate below Zero
     Click to see full size chart

    More information about



    Disclosure: Long TIPS, VIPSX, FINPX and Series i-bonds
    Themes: REIT, Bonds, Treasuries, TIPS, Series i-bonds Stocks: TIP
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Comments (3)
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  • Author’s reply » Article first published on "Kirk's Market Thoughts" at

     

    kirklindstrom.blogspot...
    18 Aug 2010, 03:27 PM Reply Like
  • Would that be like the stock bubbles in 2000 and 2008 that Jeremy Seigel did not predict or warn about either. Seigel is wrong as usual. Bonds will continue to attract lots of cash inflows until such time as the Fed gets off the ZIRP kick, which may be a long long time. Just remember Japan and the 75% equity losses lasting for almost 20 years now and the ultra low Japanese bond interest rates also lasting for almost 20 years as well. Likewise the US may well have a very very long period of ultra low interest rates, in which case there is no bond bubble anytime in the near future. And equities could well be in for serious price declines if macroeconomic conditions continue to weaken as they have been doing. Time will tell, but there sure is no rush to get out of bonds now.
    18 Aug 2010, 07:28 PM Reply Like
  • Author’s reply » You could be right. Gary Shilling was on CNBC later in the day and said bond yield had more downside left. He had a few snide comments about Jeremy Siegel being wrong on bonds while he was right on bonds for a very long time. Until the FED stops reinvesting QE1 funds that come due into USTs, it will be hard for rates to surge. If the economy gets worse and the FED starts a QE2 program to buy debt, then rates could stay low even longer.
    19 Aug 2010, 09:56 AM Reply Like
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