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AMERICA's Bond Bubble is for Suckers

 Mean Street: Say Goodbye to
America’s Bond Bubble

Wall Street Journal article
12/09/10 9:48am ET

Congratulations to all of you who bought the $1.3 billion Goldman Sachs 50-year bond back in late October.

You’re now officially a sucker. You’ve lost over 5% of your money in a little over five weeks.

Sure, you only lose it if you sell the bond – and you have the bond’s 6.125% annual yield as recompense.

But low-risk bonds aren’t really low-risk when bond yields are near all-time lows.

And you’ve now learned what you should have known before you bought the Goldman bond: America’s great bond bubble is over.

The recent rout in the U.S. Treasury market says it all. In early November, the 10-year Treasury yielded around 2.5%. On Monday, yields were at 2.9%. Yesterday, the yield spiked to over 3.3% before settling down a bit.

I know it’s hard to get too excited about numbers that end with decimals. So let me put it this way: if you own a long-term government bond fund, it’s probably off more than 10% from its 2010 peak.

That’s real money. And here’s the thing. You should have seen this sell-off coming. Rarely are events this predictable.

Certainly, by this summer, it was obvious that risk and return in the bond market were out of whack. I wrote about it a bunch of times. Heck, even PIMCO’s Bill Gross, the world’s biggest bond buyer, was saying the market was overheated.

There was simply too much money chasing too little yield. Over $5 billion a week was gushing into bond mutual funds. And the funds in turn bought anything and everything: a 10-year Treasury yielding 2.4%, a 3-year IBM corporate yielding 1%, a 5-year Microsoft note yielding 1.7%.

And more recently, the Blankfein half-century special, Goldman’s 50-year bond that pays 6.1% annually.

If you are convinced that America is the next Japan, then of course you should be buying these kinds of bonds. You still should be.

In a deflationary economy, a 30-year government bond with a 4% yield is a great bet. Japan’s 30-year bond pays a mere 2.2%.

But over three out of every four buyers of the Goldman deal were retail investors. And how could they possibly “know” the U.S. was the next Japan? How many of them have ever even visited Japan?

Such is the way of any speculative mania. There’s lots of conviction without lots of common sense to back it up.

For the past year and a half, most retail investors have been piling into bonds simply because they weren’t stocks. Stocks were scary. Stocks lost money. Stocks were so 2007.

Bonds were the anti-stock. They were “safe”. They made money. They were hot. Everyone was buying them.

Until now. Bond investors are discovering that everyone can get it wrong. It’s no accident that two weeks ago cash flows to bond mutual funds turned negative for the first time in two years.

That’s the bubble dynamic. Everyone is right, until suddenly everyone is wrong.

Now, I can’t predict exactly what will happen to the Treasury market going forward. Will the Obama-McConnell tax compromise kick-start business hiring? Will bond vigilantes force Treasury yields higher? Will the Fed engage in QE3?

Who knows? But I would bet that we’ll continue to see outflows from bond mutual funds over the next few months.

It’s one thing to be a sucker. It’s another to stay one.