Beware Of Bonds: The Bubble Seen By Jamie Dimon Isn't Exclusive To Government Debt


  • Jamie Dimon said that the only bubble he currently sees within the capital markets is government bonds.
  • Truth is, there are signs of a bubble across the entire credit market, and the signs could easily be identified not only among sovereign debt.
  • Yields and spreads of corporate debts, high-grade and high-yield alike, are trading at multi-year, sometimes all-time, lows.
  • Thing is, investors aren't only willing to accept very low yields, but they also are taking more risks while compromising for a smaller potential reward.
  • This bet may succeed if the (financial) mad world we live in continues. Nonetheless, with the odds clearly skewing toward the risk, this is an unwise, certainly not logical, bet.
  • I do much more than just articles at Macro Trading Factory: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »


Earlier this week, JPMorgan Chase (JPM) CEO Jamie Dimon said that the only financial market bubble out there right now is in sovereign debt.

First of all, it's important to note that in spite of this perceived bubble, JPM has increased its holdings in US government bonds by 52% (!) during the past year.

Secondly, he probably didn't particularly meant for US Treasuries (GOVT, BWX, IGOV, TLT, SPTL, VGLT, IEF, IEI, SCHR, VGIT, TIP, VTIP, SCHP, STIP), certainly not to short-term US Treasuries (BIL, SHV, SHY, VGSH, SCHO, STIP, GBIL).

Finally, what mostly caused Mr. Dimon to use the "bubble" reference are the government bonds that are trading with negative yields, mostly those issued by European (VGK, EZU, HEDJ, FEZ, IEUR, BBEU, IEV) countries.

Nevertheless, it's worthwhile looking at the asset class from a broader perspective. Is there a bubble in the bond (AGG, BND, BNDX, MBB, BSV, PCI, JPS, DSL, PDI, EVV, FAX, GIM) market, generally speaking?

As we wrote less that two weeks ago, we aren't buyers of bonds at this point in time. That's true when it comes to both high grade (LQD, VCIT, VCSH, IGSB, IGIB, SPSB, SPIB, VCLT, USIG, GSY, PTY, BTZ, BHK, PCN, WIW) as well as the high yield (HYG, JNK, BKLN, HYLB, SHYG, SJNK, USHY, SRLN, HYT, AWF, EMD, RA, HIO, GHY, JQC), government and corporate alike.

We also explained how rare the performances we've seen in 2019 were, and how unlikely it's to expect anything like it in the foreseeable future. Having said that, with 3.5 weeks into 2020, bonds aren't yet showing any sign they are coming to a stop. Sure, they don't (probably can't) move higher by as much as they did back in 2019, but when the total returns (since 2019 started, until and including 1/23/2020) are so high - it seems like investors are sitting still for now.

  • iShares iBoxx $ Invmt Grade Corp Bd ETF (LQD): +19.1%
  • iShares 20+ Year Treasury Bond ETF (TLT): +18.7%
  • SPDR® Blmbg Barclays High Yield Bd ETF (JNK): +15.1%
  • iShares iBoxx $ High Yield Corp Bd ETF (HYG): 14.2%
ChartData by YCharts

Is it wise? We believe not, and in this article we explain why.

Why Bond Investors Are So Cheerful?

Naturally, when someone sees a phenomenal return, it's hard to let go. Bond investors have had a fantastic year in 2019, and the assumption is that there's no reason why 2020 wouldn't look the same.

What do they count on when they expect the same trend to continue?

1. Slower Economic Growth

Although they've stated that risks are now less skewed toward negative outcomes, the IMF economists have lowered its global GDP growth forecast for 2020 again (this is a ritual) a few days ago.

Economic growth among emerging markets (VWO, IEMG, EEM, SCHE, SPEM, DEM, GEM), on an aggregate basis, is the bright spot, expected to increase from 3.7% last year to 4.4% in 2020.

2. Sentiment is Weaker

As we all know, bad news is good news, because it means that central banks will continue to pour money into the systems. With more than half of CEOs - both globally as well as in the US specifically - expecting a decline in global economic growth - monetary policies are expected to remain very supportive.

Although many more CEOs - both in, as well as outside, the US - are expecting a decline in growth rates in 2020 (compared to 2019), US CEOs remain confident about the ability of their organizations to keep growing.

3. Strong, but Not Too Strong

The current economic cycle expansion has not seen any year ending with a GDP growth greater than 3%. Add to that the recent underwhelming payroll numbers (in spite of huge fiscal and monetary policy stimulus), and the “longest (but weak) bull market” theme, which is actually being fueled by the not-so-strong economy, remains intact.

4. Monetary Policies

Malaysia (EWM) is the country to cut its rates (by 25 bps to 2.75%), joining a long list of countries that have cut rates over the past year.

Only five countries elected to tighten their monetary policies, based on the last action they took, out of which only three - Czech Republic (NQCZ), Norway (NORW, ENOR), and Sweden (EWD) - have done so over the past year.

UK (EWU) and Canada (EWC), both hiked in 2018, are actually more likely to cut soon than to keep tightening. If and when (they do so) the "last move" column would become a complete "100% green carpet."

5. No Inflation In Sight

Indeed, most measures of inflation already are trending above the Fed's 2% target, but as it seems right now, neither the Fed itself not investors seem to be worried about an outbreak.

It's enough to look at the US inflation expectations to see this. They remain well below the 2% threshold, at least for now.

Europe - The Negative Yield Hub

This week, the ECB has decided to keep the main financing rate unchanged at 0.0%. This rate has been zero for almost four (!) years now, and it doesn't look as if this is coming to an end anytime soon.

The deposit rate also been kept unchanged at -0.50%.

Even though the ECB's balance sheet has ballooned by almost 2 trillion euros (!) since the beginning of 2016, and actually doubled itself over the past five years, this hasn't translated into any sign (or fear) of pricing pressure.

Longer term inflation expectations within the Eurozone have continued to trend lower, all along, with German 5y forward breakeven rates falling to as low as 1.3% right now, after they weren't too far from the 1% level last year.

In more simple words, there's (literally) zero correlation between the size of the ECB balance sheet and the expected inflation in the Eurozone.

When the European economy was on a stronger footing, few years back, the ECB missed an opportunity to reverse its negative interest rates.

Now, everybody talks about the negative impacts of the negative-rates policy, but there's really not much the ECB can do abut it, with the economy looking as fragile as ever.

Thing is, the longer they keep that policy - the more the (negative) side effects become damaging, and the less marginal (positive) growth effect you get for every euro you spend.


What we end up with is a continent that's filled with countries that run negative yields, just to keep a very low rate of growth.

Who still has negative 2 year yields?

Mind the Bombshells

This, in turn, translates into the ETFs you're holding having many "bombshells" - some hidden some less - in them. Take for example the Vanguard Total International Bond ETF (BNDX).

As you can see, since the beginning of 2019, both the returns and mostly the AuM have grown nicely. Very nicely indeed.

ChartData by YCharts

However, what many investors don't know, or simply decide to ignore, is that such a popular ETF only offers (as of 01/22/2020) a 30-day SEC yield of only 0.53% right now, and even this low yield is containing few bombshells, just like this one:

Furthermore, not only that the yield to maturity is only 0.7%, but the exposure to Europe is 56%, and the duration is 8.1 years.

Source: Vanguard

True, this is a high grade ETF with a very low issuer risk. Nevertheless, in exchange for the high credit ratings you get yourself a big exposure to Europe, a fairly high tenor (duration) risk, and most of all - for a very little expected return (average yield).

I don't know what investors have in mind when they invest in here, but from a risk/reward perspective, this is the type of investment one may wish to back off from.

Mad World

At 2.73%, US investment-grade bond yields are currently trading at the lowest levels they've been at since 2013.

It's unreal to see how rapidly (and comprehensively) financing terms, and the credit environment in general, have improved for companies of all types and risks.

Thanks to central banks, expected to remain on hold for the time being (if not to ease further), almost any company - even the riskiest ones (see below) turns into a great "investment opportunity."

Trading back below 5%, US junk-bond yields are trading at the lowest levels since 2014. As a matter of fact, they are only 15 bps away from reaching the all-time low.

Trading back below 5%, US junk-bond yields are trading at the lowest levels since 2014. As a matter of fact, they are only 15 bps away from reaching the all-time low.

How low this us? Let's just say that during the five years through December 2006, the average 8.2 yield on that type of debt was 8.2%.

Back to Europe now.

Per the Bloomberg Barclays European Banks CoCo Tier 1 index, the average yields on European banks' (EUFN) contingent convertible (aka "CoCo") bonds fell to the lowest ever since data started to be recorded (on an aggregate basis) three years ago.

Just like the BNDX that we've touched upon above, this record-low yields are being accompanied by longer durations.

Since 2014, the duration of the average government bond index is up 1.5 years in the US and a full two years in the Eurozone.

Why this is important? Because if and when yields start rising, the free-fall would be greater than ever before.

Again, this is a double-edge sword, as bond investors are taking more risk for much less reward.

Bottom Line

Some may wish to claim that on a relative basis, bonds can deliver even more gains than they already did. Technically, this is a valid claim.

Even spreads on Eurozone corporate bonds that have dropped to 0.90%, the lowest level since March 2018, traded at about half that (average) spread during 2004-2006.

So technically - sure, the spread can move lower and you can make 40 bps more. However, when you recall that the average spread also traded at near 5% 11 years ago - I'm not sure that potentially gaining 40 bps vs. potentially losing 400 bps is such a great trade-off.

There are still opportunities across the bond market. There always are bonds that trade at very high yields that may, under the right circumstances. deliver phenomenal gains.

For example, if you invested in the Argentinean (ARGT, AGT) 10-year bond only 3-4 months ago - the yield to maturity has already halved, meaning you've benefited from tremendous gains.

However, that's the exception, and even this exception is far from being a risk-free investment opportunity, to say the least.

It's not only a "mad world", or a "bubble," but also a market that's seeing more and more credit cracking signs. Take delinquencies vs. C&I (business) loans as a percentage of GDP that seem like they're starting to converge.


When the cracks widen, and credit conditions start worsening, yields would have to start heading higher, even if the monetary policies remain very loosened. This will happen through spreads (risk premium), so even without the cracks in the credit market widening, this could be more than enough to cause some real damage to bond holders.

What should be absolutely clear to anyone holding medium-long duration bonds right now is that you're sticking to assets that under the best-case scenario will deliver very little gains, and under a worst-case scenario would be looking as bad as a major stock (SPY, DIA, QQQ, IWM) correction looks like!

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