{"id":876,"date":"2015-04-25T23:41:36","date_gmt":"2015-04-25T23:41:36","guid":{"rendered":"http:\/\/www.wallstreetandkstreet.com\/?p=876"},"modified":"2015-04-27T12:49:27","modified_gmt":"2015-04-27T12:49:27","slug":"bubbleicious-dont-get-too-comfortable-in-this-new-era-of-negative-bond-yields","status":"publish","type":"post","link":"https:\/\/www.wallstreetandkstreet.com\/?p=876","title":{"rendered":"Bubbleicious: Don\u2019t Get Too Comfortable In This \u201cNew Era\u201d of Negative Bond Yields"},"content":{"rendered":"

Bottom Line:<\/strong> Bond yields may stay absurdly low for quite a while longer, but eventually sanity will prevail and bond bulls will get killed. Don\u2019t let Europe\u2019s negative yields, and their spillover into the U.S., cloud your thinking about the appropriate PE for U.S. equities.<\/p>\n

In the real world, as opposed to the make-believe mathematical world of economists, economies stagger from one mania to the next, much as drunks stagger from lamp post to lamp post. Often one mania corrects the imbalances created by the previous one. The current mania was captured in a recent FT <\/strong>headline: \u201cSwitzerland makes history by selling 10-year debt at negative interest rates.\u201d German 10-year bunds yield all of 20 bps, meaning it would take 347 years for an investor to double his money. Debt with an aggregate value of several trillion euros carries negative yields.<\/p>\n

This is really weird. It\u2019s like telling your landlord, \u201cI\u2019m willing to stay in the apartment for another year, but forget about that rent check I\u2019ve been sending you. From now on, you pay me $300 a month. Is that clear?\u201d No reversion to sanity is imminent; Mario Draghi promises to stay the course on his bond-buying program. But it\u2019s not all Super-Mario\u2019s fault; Europe needs his monetary medicine because it refuses to make pro-capitalist structural reforms.<\/p>\n

No Historical Parallels<\/strong><\/p>\n

To find out just how unusual negative bond yields are, I consulted UK interest rate data on measuringworth.com, the valuable compendium of historical data created by Lawrence H. Officer and Samuel H. Williams.* (I used UK data because, as a more mature and wealthy economy than the U.S., interest rates tended to be lower.) Between 1729 and 2014, the lowest annual bond yield was 2.15% in 1897<\/strong>\u2014a hefty 221 bps above where Switzerland sold 10-year bonds last week. That 2.15% yield in 1897 occurred in a period of bona fide deflation; prices declined 0.2% per year during the prior decade. Today, by contrast, the UK is experiencing inflation of around 3%, so deflation provides no justification for today\u2019s low bond yields, as some people claim.<\/p>\n

It\u2019s all about monetary policy. Central bankers are the new Masters and Mistresses of the Universe (move over Bernie Ebbers of WorldCom, Ken Lay of Enron and Angelo Mozillo of Countrywide Financial). They are vacuuming up bonds and driving up prices. Private traders are happy to go along for the ride. An HSBC strategist told the FT, \u201cWe have unconventional central bank policies at work so you have to expect unconventional outcomes. One is that bonds are no longer trading like bonds. They now trade like commodities, with investors speculating on the price.\u201d<\/p>\n

This notion that \u201cbonds are no longer trading like bonds\u201d is worth wrapping your brain around; it is this cycle\u2019s analogue to Chuck Prince\u2019s fatally prescient comment in July 2007, \u201cWhen the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you\u2019ve got to get up and dance. We\u2019re still dancing.\u201d My loose translation of the HSBC comment: These prices are crazy; there is no intrinsic value in bonds with negative yields. But who cares? We are speculating on short-term price changes, not investing. <\/strong>Whether it is tulips, tech stocks or houses, this is the telltale indication of a \u201cbubble\u201d\u2014prices are being set by traders who don\u2019t care if the assets they buy and sell have intrinsic value. The trend is their friend (until they fall off the cliff).<\/p>\n

Bubbles 101: Five Facts to Keep in Mind<\/strong><\/p>\n

After making mistakes in the stock market for thirty years, I have a few observations that put the bond bubble in historical perspective.<\/p>\n

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  1. This bubble is quite unusual in that it is widely recognized as a bubble. <\/strong>Most observers understand that negative yields are ridiculous.<\/li>\n<\/ol>\n

    2. \u00a0This bubble is not<\/span> unusual in being government-sponsored. <\/strong>For example:<\/p>\n