Crescenzi: Bond Bubble Babble
Senior VP, Strategist, Portfolio Manager Pimco
With respect to the valuation of bonds and the notion of a bond bubble, these ideas stand out:
1. By standard valuation metrics, Treasury yields are not misaligned with historical norms. Specifically, yields are low because both inflation and the fed funds rate are low. Investors should view the low inflation rate and the near-zero fed funds rate as anchors to yields across the yield curve. The ship can’t go far with the anchor down and so firmly entrenched. (Track the bond market here.)
2. The savings rate is rising because people want to rebuild their finances following big losses on their homes and stocks. This means money will continue to funnel toward investments deemed relatively safe.
3. Cash flow in the final analysis is crucially important to any comparison between the bond market and the many stock market bubbles that have existed. In the case of the stock market in 2000, investors expected ever-increasing increases in cash flows for many companies that eventually had none. In contrast, the cash flow for many bonds is likely to be sufficient to meet the obligations of entities issuing bonds. For example, corporate bonds are being buoyed by very strong corporate balance sheets and companies are sitting on boatloads of cash. This makes it more likely that companies will repay investors. This makes the bubble argument moot, essentially, because the risk of a loss of principal on bonds held to maturity is lower. Of utmost importance to a bond investor is getting his or her money back. In U.S. Treasuries, the availability of the printing press virtually assures that bond investors will get their money back, even if it means more inflation for the broader economy.
4. Bonds are for many investors good insurance against equity losses and hence have value even when they decline in price. Investors are more willing these days to own bonds as a hedge against losses in equities or assets carrying equity-like risk.
5. Investors, having experienced two shocks in equity prices in a decade, are unlikely to suddenly become enamored with equities with the same verve as existed in the 1990s before the financial bubble burst. Note that households represented 50% of the stock market’s capitalization in 1999. After the bubble burst, they pulled back. Yet, even as the equity market recovered and the Dow Jones Industrial Average hit its all-time high in 2007, households did not return, representing just 37% of the stock market’s capitalization in 2004-2007. In other words, despite a long passage of time and a rally in stock prices, investors did not return to the stock market with the same verve as in the 1990s. If investors did not return after the bursting of the financial bubble in 2000, how could we expect them to return after the recent shock?
6. A demographically aging population is likely to have a lasting appetite for bonds, which are higher in the capital structure than other asset classes, meaning bondholders are first in line relative to equity investors in cases where companies face difficulties.
Tony Crescenzi is Senior VP, Strategist, Portfolio Manager Pimco. Crescenzi makes regular appearances on financial news stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."