Bond Bull Market: Reports of its Death are Greatly Exaggerated

A client or two mentioned Russ Wiles' column in Sunday's Arizona Republic entitled "Bonds Not Looking So Attractive". In it, Russ (a good friend of ours and an experienced investment columnist) cites several market observers who point out (to varying degrees) the obvious reality that the bull market in bonds is rather long in the tooth.

Of those observers, PIMCo's Bill Gross is one we hold in the highest regard. Mr. Gross recently turned the attention of his monthly missive on that bond bull market and warned that the end may very well be nigh. We have no qualms with Mr. Gross' view (who are we to disagree with the greatest bond manager in the history of the world?). The sticking point is just how nigh is "nigh"? We highly recommend reading Mr. Gross' column.

It is, however, the unnamed portfolio managers at Ariel Investments in Chicago with whom we take issue. More to the point, it is their proclamation that "we have reached bubble territory in bonds" that we find misguided.

Three quick points to challenge this silly bubble talk:
1) How can we be in a bubble when the worst outcome an investor can possibly experience is a positive 4.3% annualized return (yield to maturity on the 30-year treasury bond)?

2) How can we be in a bubble when the overwhelming majority of investors are betting AGAINST bonds? (The Chicago Board of Trade reports that the net speculative short position in long treasuries has grown to 13,048 contracts, each of which represents $100,000 of face value.)

3) The definitive refutation of bond bubble talk comes from the brilliant folks at Hoisington Investment Management, the guys who have gotten the bond market right for the past thirty years. In their latest Quarterly Review and Outlook, Van Hoisington and Dr. Lacy Hunt write

A bubble, however, refers to an asset with a price that is substantially beyond the asset’s fundamental or intrinsic value.

Let's cut to the chase:

. . . investors are still able to purchase long-term Treasury securities at prices which do not yet reflect their positive long-run potential.

In other words, it is a stretch to describe the current bond market as a "bubble".

As wrong as we believe the Ariel folks may be about a "bubble", we concede Mr. Gross may be right that the bull market in bonds is about over. With Japan's experience fresh in our minds (along with virtually every other recorded financial crisis*), we do not yet agree.

*The work of Carmen S. Reinhart and Kenneth S. Rogoff have been invaluable in the evolution of our investment strategy over the past two years. To paraphrase their early work - the aftermath of financial crises share three characteristics:
First, asset market collapses are deep and prolonged.
Second, the aftermath of banking crises is associated with profound declines in output and employment.
Third, the real value of government debt tends to explode.

This Time is Different: A Panoramic View of Eight Centuries of Financial Crises
Carmen M. Reinhart and Kenneth S. Rogoff
April 16, 2008

The Aftermath of Financial Crises
Carmen M. Reinhart and Kenneth S. Rogoff
December 19, 2008