Is The Bond Market Predicting A Crash?
The Dynamic Wealth Report
August 24, 2010
by Jay Chernoff, Editor
The financial experts are predicting doom.
Lately, the media is pulling out big scary names to describe the markets.
There are some really colorful terms floating around.
It’s the Hindenburg Omen! It’s the dreaded Death Cross! Wow. I guess we
should all run for the hills…
Clearly this terminology is meant to terrify us about the coming
financial apocalypse.
You know what I think… It’s all a bunch of baloney.
Let me tell you what I think…
You can put all of your money into cash and wait for a crash. Or you can
keep your money in the financial markets and profit as the economy
improves.
Look, I’m not saying we’re at the cusp of a major rally… or at the edge
of a crash. But let’s maintain some composure. What we really need to do
is consider the facts.
So let’s take a closer look at the bond market.
In my opinion, the bond market is the best overall gauge of our economic
well-being. Bond traders tend to have a strong grasp of the big picture.
What’s more, bond traders are always monitoring expectations and
economic data. Because of this, bond prices are often forward looking.
But wait… have you seen the 10-year bond lately?
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10-year yields are at their lowest point since March 2009. That’s back
when the financial markets were in turmoil. And some were predicting the
end of the banking system as we know it.
Bonds offer about a 2.50% annual rate… for 10 years! You could probably
throw darts at a Wall Street Journal and pick an investment with a
higher yield than that!
By the way, remember what happened in 2009, the last time yields got
this low?
Nothing.
As a matter of fact, the world didn’t end. Pandemonium didn’t erupt in
the streets. American Idol wasn’t even cancelled.
So why are bonds once again trading at such a low yield? Are bond
traders also predicting a crash?
The last time yields were this low there was a legitimate risk of a
global financial meltdown. The banking system was in huge trouble. The
government had to step in to save several major financial institutions.
Plus, real estate prices were plummeting with no end in sight.
But this time around, things are different.
Yes, real estate and the job market are still issues. But… they haven’t
gotten any worse. In fact, there have been some small steps towards
improvement.
More importantly, the major banks are healthy. They’ve been forced to
eat their losses. The Fed has supplied them with huge reserves of cash.
And, they’ve cut costs and increased profits.
I don’t know about you, but it hardly seems like our financial system is
about to fail.
So then, why are bond yields so low?
Something else must be going on in the bond market.
First off, there’s the unusual situation of excess liquidity. Central
banks across the globe are printing money to combat deflation. And large
banks are sucking up this excess cash.
Here’s the thing… the banks aren’t loaning the money back out. Instead
they are investing it in super safe assets… like Treasury bonds.
But it’s not just liquidity driving bonds higher.
There’s also the issue of foreign government risk. Normally, government
bond investments get spread out across the globe. But even some of the
historically safest governments are dealing with questions of
creditworthiness. Europe is a leading example of this situation.
So by default, all the money is flowing into U.S. Treasuries. Even with
all of the economic issues, the U.S. still has the biggest economy and
the safest bonds.
Here’s another theory about the low bond yields…
Nobody has any better investment ideas.
Look at the alternatives.
In recent weeks, equities are lagging. Real estate is still stagnant.
Commodities are volatile.
Investors don’t know where to turn. For lack of any better ideas, they
dump their money into Treasuries. Boring maybe, but secure.
Don’t get me wrong…
I don’t think bonds are in a bubble. You need to have rampant enthusiasm
to create a bubble. Like the way internet stocks were going up in the
late 90’s. As far as I can tell, no one is all that enthusiastic about
earning 2.5% a year in bonds.
On the other hand, I do think Treasury yields will slowly start to
increase. It just may take a few months.
But here’s the key point…
I don’t think we’re headed for a crash. The fundamentals of the economy
are bad, but not THAT bad.
In general, big companies are still doing pretty well. What’s more, the
financial system is flooded with cash. Major banks simply won’t fail
with this kind of liquidity.
It’s not a bad idea to keep some of your money in cash or Treasuries. But don’t be afraid to invest in the equities market. You’ll be glad you
did as the economy improves.
After a couple busy weeks, the IPO market took a vacation. No new IPOs
to report. A recent IPO, Primerica (PRI), is performing extremely well
in a tough market. Since its May launch at $15, the share price has
jumped over 40% higher.
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