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Bond Bubble and the Great Rotation


Just because your brother-in-law isn't giving you hot Treasury tips, don't think we're not in a bond bubble. We are. Prices will go lower. If you're in a bond fund or ETF, get out while the gettin's good.

This article is published with permission from

Last Friday, John Waggoner wrote in USA Today that he didn’t believe Treasuries were in a “bubble.”

His claim was based on the fact investors aren’t “bragging about how they bagged a 30-year T-Bond at auction.” He also noted they don’t mark their calendar “for Treasury auctions, hoping to scoop up a couple of two-year T-notes at 0.23% yields.”

In other words, investors aren’t euphoric about Treasuries the way they were about stocks in 2000 or real estate in 2006.

Waggoner is right about one thing. I can’t remember being at a dinner party when someone excitedly told me about the Treasuries they just bought.

And while folks might not be boasting about it, someone is sure as heck buying an awful lot of them.

While the story of the “Great Rotation” from bonds into stocks makes great headlines, it’s not entirely accurate.

True, stock funds took in $78.88 billion so far this year. But taxable bond funds have grown by $76.41 billion. Not exactly a flood of money coming out of bonds and into stocks, is it?

And money is still coming into Treasury bond funds. Treasury-based ETFs added $810 million. And in the last week of March, taxable bond funds added $3.8 billion.

Holding back

From 2007 through 2012, a staggering $610 billion was taken out of domestic stock mutual funds. (On a side note, as stocks bottomed in March 2009 and went on to double, investors were getting out of the market at exactly the time they should have been getting back in.)

According to Ryan Detrick of Schaeffer’s Investment Research, only 3% of that total has been put back into equity funds.

Clearly, none of the statistics comes anywhere close to showing a “Great Rotation” into stocks.

And though the market hit record highs last week, sentiment is hardly in bubble territory. The most recent American Association of Individual Investors (AAII) sentiment poll shows 35.5% of respondents are bullish. That’s nearly three points below the long-term average.

At the market high in October 2007, right before stock prices dropped dramatically, AAII’s bullish reading was near 60%.

I can’t tell you if stocks are going to keep climbing higher or if they’re going to correct. I dropped my crystal ball in the shower (don’t ask) and I didn’t get the extended warranty.

But the idea stocks will stop advancing because sentiment is so high and everyone is buying stocks is just plain wrong.

Just like the notion that bonds are not in a bubble because you don’t hear about physicians quitting their practices to trade Treasuries … all you have to do is look at the cold, hard numbers.

Money is still pouring into bond funds, which is just plain crazy.

If an investor needs fixed income, buying some bonds with short-term maturities makes sense as long as the investor plans on holding the bond until maturity and doesn’t mind a tiny yield.

But unlike a bond, which pays a defined amount (par) at a specific time (expiration), a bond fund will only be redeemable at its trading price — which is likely to be lower as rates rise.

The difference between a stock bubble and bond bubble is a stock bubble can continue to inflate to higher and higher prices. Because interest rates can only go so low (about where they are right now), prices can’t climb much higher, which means there is only one direction that bond prices can go.

Rates have to go higher. And the last thing you want is to be trapped in a bond fund that is falling in price.

So just because your brother-in-law isn’t giving you hot Treasury tips, don’t think we’re not in a bond bubble. We are. Prices will go lower. If you’re in a bond fund or ETF, get out while the gettin’s good.

Marc Lichtenfeld is a senior analyst at Investment U. See more articles by Marc here.

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