Don’t be surprised if someone soon creates an ETF to track the verbiage expended by traders, investors, and the financial press about a bond bubble.
In the trading pits and on fixed-income desks, there’s a general appreciation that bonds today, with their puny yields and vastly appreciated values, seem rich. The press and brokerage firms, having remembered how they (we) whiffed on calling the bubble in subprime and financial engineering, can’t help declaring that bonds at these levels are a ticking time bomb, so run—don’t walk—away!
But bond mania, and the attendant hand-wringing over it, could go on for a while. There’s a lot—institutionally, generationally, situationally—driving that seemingly indefatigable bull.
Look at the (above) chart from Birinyi & Associates, which shows how many cautionary, even alarmist, headlines have overlayed the run of the past six months, amid a record year for bond issuance and buying.
This week, the Twitters have been abuzz with the search-engine-optimized headline, “Goldman Sachs Prepares for a Bond Market Explosion.” And Pimco’s Bill Gross, the bond king, calling a Credit Supernova, which, you must admit, is admirable candor from the human being who most benefits from the bond bull; his Pimco manages nearly $2 trillion of the stuff.
“I don’t like the word ‘bubble,’” says Citigroup’s Tobias Levkovich. “It’s an easy word to say and hide behind—a generic attention-grabber when these types of conditions can persist for longer than people realize.”
Levkovich is no bond Pollyanna. His research shows how the hundreds of billions of dollars of hot money flowing into the category resembles the rush into tech and growth equities when the market was at Y2K nosebleed. And yet Levkovich says he is also mindful of the desperation to secure retirement returns that has so many Americans piling into bonds, whatever their yields. Even as U.S. Treasuries tasted some volatility to start the year, global corporate bond issuance just had its busiest January on record, following its biggest-ever year. Wall Street knows it has what investors think they need, and corporations are all too willing to borrow money at those historically low rates.
Corporate bondholders could see “massive outflows” this year as investors shift their allocations toward stocks and higher interest rates loom, wrote a group of Bank of America Merrill Lynch credit analysts led by Hans Mikkelsen in a Jan. 28 report. That rotation, they wrote, is “the biggest risk to investment grade this year and the one we are getting increasingly concerned about.”
As for Uncle Sam’s house tab, investors bid a record $3.16 for each $1 of the $2.011 trillion in bonds the U.S. government auctioned in 2012, according to Treasury data.
“The Great Rotation?” wrote Citigroup’s Vikram Rai on Thursday. “Not Quite.” He notes: “Even if speculation regarding the ‘Great Rotation’ were true, money fund managers needn’t worry given that their asset class caters to a very different investor base when compared to the equity investor base.”
Case in point: According to the Conference Board, nearly two-thirds of Americans aged 45 to 60 say they plan to push back retirement, compared with 42 percent two years ago. All this as once-productive bank accounts throw off pennies, and despite the fact that the stock market is at levels not seen in five-plus years.
“An asset price bubble is when the expectation that the price can only go higher forms the only rationale for purchase,” remarked BlackRock’s bond honcho Jeffrey Rosenberg Thursday at the CFA Society of Los Angeles’s Economic & Investments Forecast Dinner, at which the “wherefore bond bubble” discussion dominated. “But the main motivation of investors for buying fixed income is the opposite of typical bubbles—the fear of losing money rather than the greed of potential profit has fueled the historic shift of assets into fixed income.”
As my Washington colleague John Detrixhe has reported, foreigners are still piling into Treasuries, overcrowded conditions be damned: “America’s currency is proving to be a store of value even though ratings firms are questioning the creditworthiness of the U.S., helping to attract the international capital needed to help support an economy poised to grow almost twice as fast as the rest of the developed world.” He calculates that foreign holdings of Treasuries have surged 81 percent, to $5.6 trillion, since the end of 2008. Non-U.S. investors now own half the securities, compared with 43 percent six years ago. Credit/blame the flush Chinese and risk-shell-shocked Europeans.
So the growing league of bond naysayers have all that—and a bond-adoring Federal Reserve—working against them.
Not that this won’t necessarily end in spectacular heartbreak. Back to that Goldman Sachs news. Read past the pyrotechnic headline, and you’ll learn that the investment bank is paring its bond and interest-rate exposure. Chief Executive Officer Lloyd Blankfein and Chief Operating Officer Gary Cohn have lately been making bearish hints (rather, exclamations) to that effect.
Students of the subprime bubble, and the Vampire Squid theorem, might recall that these were precisely the guys who started wagering against mortgages just before that asset fell apart and took the entire global economy down with it.