Friday, December 12, 2008 2 comments ++[ CLICK TO COMMENT ]++

US Treasuries not in a bubble but overvalued?

Mark Hulbert interviews a newsletter writer, Dan Seiver, who says that US Treasuries are not in a bubble but are simply overvalued:

The reason Seiver doesn't believe bonds are forming a bubble is that the bond market is not rallying because of greed. He argues that greed is a key distinguishing characteristic of investment bubbles--whether of the Internet bubble of the late 1990s or tulip bulb mania in the 1600s.

In contrast, Seiver points out, bonds are rallying out of fear: Investors are so scared that companies will become insolvent that they are not only unwilling to invest in them, they aren't even willing to lend them money.

All this said, however, Seiver nevertheless believes that long-term bonds are a very poor bet right now. "The chances of achieving capital gains from buying long-term bonds right now are extremely low," he said.

One might wonder what the big deal is if bonds are overvalued regardless of whether they are in a bubble or not. Well, the slight difference matters a whole lot to bond bears. I, as well as many others, have been entertaining the idea of shorting the US bond (the TBT inverse ETF is a simple choice.) But if it is simply overvalued rather than being in a bubble, then the potential returns are likely to be very small. Bond yields can take a long time to change--we are talking years--and if prices drop 20% over 3 years, it may not be worth it at all.

Anyway, I don't share the opinion of the quoted individual and still think that bonds are in a bubble. It's not a strong enough opinion for me to invest my money one way or another. I'm bearish but what's holding me back is the potential for the Chinese economy to implode. To see what I mean, notice how China is thinking of devaluing its currency (the free-market band that the currency fluctuates in is totally bogus and what matters is government policy remarks,) which is very bullish for US government bonds.

Another risk for bond bears is that, if one is bearish on US government bonds, they are implicitly bullish on the US economy (an exception is if the US government defaults but I do not see that happening.) I personally can't see the bullish economy call. I know a lot of commodity bulls are betting heavily on so-called re-flation but I don't see it. I do not think we are anywhere near a Depression or will enter one, but subdued, low, growth for years seems plausible. I think a 1% GDP growth will be bullish for bonds. In such a scenario, where trust is still lacking in the system, I think "bond bulls" will be happy to give their money to the government at 3% return for 10 years or almost 0% for an year.


2 Response to US Treasuries not in a bubble but overvalued?

December 12, 2008 at 12:52 PM

If there were no Federal Reserve, I'd be shorting bonds in size.

But there is a Federal Reserve that has announced[?]/ruminated[?] about buying out the yield curve.

They can buy as much as they want with newly-created dollars. And the only reason for them to stop that I could see is if all this new money started driving up prices to crazy levels.

Incidentally, this is what happened from Summer 2007 to Summer 2007 -- the Fed was cutting interest rates and doing putting out its alphabet soup begging bowl for financial institutions, but it was mostly exchanging treasuries for toxic paper. It was not monetizing treasuries.

I think part of the reason it did not monetize -- i.e., "inflate" -- over this time period is that oil and other commodities were surging.

But now that commodities have busted and the dollar has put in a sizable rebiound, the Fed has a much freer hand to buy treauries (again, the other words for that are "print money," "monetize," "inflate," etc.).

Also, the Fed has run down a sizable portion of its trasuries anyway. I think that's one reason it's floating ideas about issuing its own debt -- it doesn't want to beg the treasury for a new supply.

In other words, if you short treasuries right now, you might be right on the money, fundamentals-wise -- but you're going up against a monster with unlimited firepower.

But at some point consumer price increases and/or price controls will result from all of this.


December 13, 2008 at 7:16 PM

I'm not too sold on the inflation view. If more credit is destroyed than is created, I'm not sure how inflation will materialize, even in a few years.

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