When Will the Bond Bubble Burst?

8 tax breaks that cost Treasury trillions

When will the bond bubble burst? The U.S. Federal Reserve's action yesterday — indicating it would continue stimulus for as long as it takes to get the unemployment rate down to 6.5 percent or below — has reignited debate about the Bond Bubble.

It was the biggest call of 2012: Sell bonds, particularly Treasurys. It was also the biggest loser. No sell-off has occurred. Bond inflows remain huge: Bond mutual funds have seen inflows of $242 billion this year, bond exchange-traded funds have seen inflows of $51 billion.

Compare that to OUTFLOWS of $127 billion from stock mutual funds.

The biggest bond funds, including Vanguard Total Bond Market (BND) and the iShares Barclays Aggregate Bond (AGG), still have not seen significant outflows.

But yesterday's spike in bond yields has re-ignited the debate and emboldened the bond bears. They point out that the 10-year Treasury note hit its record-low yield (1.38 percent) back on July 25, or five months ago.

Yesterday, at The New York Times Dealbook Conference, David Rubenstein of The Carlyle Group admitted he didn't know when the bubble would burst, but said, "The greatest fortune made in the next five years is probably going to be made by some group or individual who figures out when the interest rate market will turn," according to CNN.com.

Lloyd Blankfein, at the same conference, warned that investors were "complacent about the low level of interest rates," and predicted there could be losses for investors with lots of bonds in their portfolios.

Ray Dalio of Bridgewater Associates predicted rates would begin to rise toward the end of 2013. (Read More: Shorting Bonds Will Be Big: Dalio)

The timing is one thing, but where to go is another. Out of Treasurys, into stocks? Out of junk bonds, and into floating rate debt?

You will now begin to hear more about this.


1) Low interest rates killing financials: Insurer MetLife became the latest to acknowledge what everyone already knows — low rates really are hurting the outlook. MetLife gave 2013 earnings per share (EPS) guidance of $4.95 to $5.35, well below consensus of $5.48 a share, due to the low rate environment. How so? It invests its premiums, and makes assumptions about the returns on those premiums. According to analysts, built into the guidance are assumptions of a 5 percent rise in the S&P 500, with a 10-year yield of 1.65 percent (below the current 1.71 percent). In other words, not much of a return.

2) European Union leaders met for the sixth time this year and agreed to make the European Central Bank the top banking supervisor. This is no small deal: It's another step toward closer integration. There are two additional parts to a banking union that still need to be addressed: deposit guarantees across the euro zone, and a joint fund to wind down failed banks.

It's been a momentous year for the euro zone: The bureaucrats have been able to keep Greece in the club, negotiated a bailout fund, and now approved the ECB as the chief banking regulator.

More importantly, there has not been (yet) an open revolt by the electorate against the slow but steady march toward European integration and a surrender of national sovereignty.

This will be tested in Italy, where there are early elections and where Silvio Berlusconi is already trying to claim that the Germans are trying to take over Italy. The populists will be out, all year. (Read More: If Germany Sneezes, Does Euro Zone Catch a Cold?)

3) Two initial public offerings today: SolarCity (trading under the symbol "SCTY") prices 11.5 million shares at $8 each after postponing its IPO earlier this week amid a struggling solar sector. The Elon Musk-backed company originally planned to offer 10.1 million shares between $13 and $15.

PBF Energy (trading under the symbol "PBF") prices 20.5 million shares — four million more than expected —at $26 apiece, in the middle of a $25 to $27 range.

4) Two companies set to open at historic highs after providing upbeat guidance:

Boston Beer rises 14.2 percent after the Sam Adams brewer raised its 2012 profit outlook due to stronger shipments. SAM now expects 2012 EPS of $4.30 to $4.60, up from a previous range of $3.80 to $4.20 and above the Street's $4.21 view. The company said its rosier outlook could also be partially attributed to the timing of administrative and other expenses.

CVS Caremark gains 4.9 percent after giving 2013 earnings outlook above what the Street expects. CVS sees 2013 EPS of $3.84 to $3.98, higher than analysts' $3.82 view. The drugstore chain said it perceives changes in the health-care system as an opportunity to benefit by serving more customers and filling more prescriptions. CVS raised its quarterly dividend by 38 percent to $0.225 a share from $0.1625 a share.

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