Investing With Jay Today

May 24, 2009

Are Long Term Bonds a Bad Investment Today?


Q: On May 7th, Richard Russell wrote, ¡°If there¡¯s trouble ahead, it will show first in the long-bond ¡­ The bond has been coming down and is now testing its important 50-week moving average. MACD (moving average convergence / divergence) is bearish - this is the place where the world¡¯s central bank is looking. Of course, behind the bond is the strength or weakness of the US dollar. If the Dollar Index hits 82, you can kiss the long bond "good bye." (See Dow Theory Letters.)  On Friday, May 22nd, the Dollar Index was down to 80.03. Do you agree with Russell on this point?

A: First of all, at the outset you must understand the term "bond market" generally means long term bonds, usually 20 years or more. That's the way I will use the term. Short term bonds are really more like cash substitutes.  I agree with Russell that the dollar index and long bond price are two of the best places to watch for signs of trouble in the financial markets, but either could give a wrong signal. I have no doubt Russell understands this. The reason I mention it is that there has been so much manipulation by the Fed, and so much chaos during the recent panic, affecting both the dollar and bonds that the free market is not functioning as it should.

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Learning from the Masters Today and Tomorrow 
(Letter 23)
Whom to Listen To (Letter 3)

Q: On May 7th, Richard Russell wrote, "Everything is fine, as long as the bond market says it is ... Remember, the bond market is far far bigger than the stock market." I recently heard that the U.S. bond market is almost twice the size of the combined market capitalization of all U.S. stock markets, and the world bond markets are actually 5-10 times larger than all the world's securities markets. Does this sound correct to you?

A: Yes, and probably the difference is increasing faster now than it ever has. It makes some sense that there would be more bonds. Both corporations and governments issue bonds. Only corporations issue stocks. Until the 1960s or so, most of the larger buyers of investments (governments, insurance companies, pension funds, etc.) bought more bonds than stocks because they were considered safer.

Q: If so, why do you think everybody spends so much time and energy on the stock markets?

A: My answer would be greed. Although stocks are much riskier, much greater fortunes can be made much faster in stocks. At the interest rates over the past ten years, adjusted for inflation, to begin from scratch and compound to any sizable fortune would take a lifetime. People want to get there faster.

Q: I can't recall you writing much about the bond market.

A: The main reason is it's a poor value now, in fact actually a bubble. The only reason I would want to buy it is as a part of my deflation hedge, and for most of the last 100 years it has been the best deflation hedge. Presently, I would not want to be either long or short of long term bonds. This has been Jim Rogers' position for several years, i.e. that they are grossly overvalued (bubble), and a candidate for short selling, but He will not short them while the Fed is manipulating the price. Neither have Russell or Maybury owned long term bonds to my knowledge.

Q: Can you share a summary of your lifelong knowledge of where bond markets have been, where they are now and where they are going?

A: From around 1900 until 1941, we had a secular bull market in bonds. The yield fell below 2% at the top of the bull in 1941. (I don't have the high yield for the early 1900s). Then from 1941 till 1981 we had a forty-year secular bear market in bonds, the yield rising from under 2% to almost 15% on the 30 yr treasury. In other words, the free market priced interest rates to recognize the continuing inflation of the currency all during this period. From 1981 till today we've had a 28-year secular bull market with the yield falling from 15% to just under 2% recently. Thus the long Treasury bond has come full circle from 2% to 15% and back to 2% over a 69-year period.

30 Year US Treasury Bond Yield, 1930 to 2009
(This chart is hand-made, so it's only an approximation.)

The first bull is easy to understand, we had a gold-backed currency and a depression. The bear market is easy to understand, we had a fiat currency and growing inflation, and a free bond market. Volcker ended that bear market with his huge increases in short term interest rates. Then the world's savers began buying our government bonds subsidizing our deficit spending. This kept the bull bond market going until fairly recently. It would surely have ended a few years ago and a new bear bond market started IF the government had permitted the free market to operate.

Q: Do you think the current 28-year bond (bull) market is being artificially extended?

A: Yes, beyond the slightest doubt in my mind. I believe the US long bond has been manipulated for at least the last ten years.

Q: If so, how long do you think this can go on?

A: Indefinitely, until the government quits debasing the currency and allows the free market to determine interest rates and bond prices, or until some kind of unpredictable financial cataclysm occurs.

Q: How do you think a burst in the bond bubble will affect everything else?

A: Assuming it did collapse (yield shot up), I would guess the world stock markets would collapse. After they bottomed out, capital would begin flowing into bonds which might return to their safe-haven role as a portion of personal savings, retirement funds, foreign investment, etc. flowed back into bonds. This could bring down inflation, stabilizing the dollar, and in time the stock market could recover, if we could get rid of government interference in the free market. This is how Volcker got us out of the mess we were in in the 70s.

Q: How about US corporate bonds? What do you think about these as investments and factors in the overall economy?

A: I would not want to own any long term bonds of any kind now. They are the most overpriced asset class there is in my opinion. Some will pay their interest and face amount at maturity, but I would not want to be a portfolio manager trying to guess which companies will take bankruptcy (and default on some or all their bonds) and which will survive. And remember, corporate bonds don't have the full faith and credit of the government behind them. I am thankful I don't own any corporate bonds now. When this recession (or depression) is over, corporate bonds could become good investments again, but there's no way to know now when that will be.

Q: How about global government bonds as a whole, aside from US bonds?

A: I have no expertise in bonds of other countries and would not want to comment. I just believe all long term bonds are way over priced, which was clearly stated in our discussion.  I am not an expert on the fundamentals of world bond funds, nor have I researched them, nor have Rogers, Maybury, etc. invested in them so far as I know. Therefore, neither would I. But let me try to note some things that I hope might be of value on the subject.

The most important things you must know about bonds before investing in them

  1. What is the financial strength and credit worthiness of the borrower (issuer of the bonds: country, corporation, state, etc.)?
  2. What is the term of the bond (years to maturity, or average time to maturity in the case of a bond fund).
  3. Where are we in the secular bull-bear bond cycle?
  4. How close is the yield to maturity of the bond to the inflation rate of the currency in which it is denominated?

There are rating agencies which help with (1), but they are falling into disfavor these days. AAA used to be the closest thing to a guarantee. Not any more, and I read recently that there are only a dozen or so US corporate bonds with AAA ratings today. US treasury bonds are the only ones you can rely on as completely safe in my opinion.

Number (2) is almost as important as (1) because long term bonds (20 years and up) can create fluctuations in market value as scary and volatile as the stock market.

Re number (3), I am as sure as it's possible to be that we are in a bubble in long term bonds, someday facing a huge collapse and long bear market.

Number (4) is an easy one to answer. In the main, the yields are well below the loss of purchasing power of most currencies.

CONCLUSION: Do not buy long term bonds of any kind, PERIOD!!!!!! I would not even buy 5 or 10 year bonds today. Hold cash in the safest bank deposits, money markets or CDs you can find.

Q: Finally, do you expect most of the US middle class to disappear in the next few years?

A: Yes, in the absence of letting the free market operate and clean out the system, I fear the middle class will shrink a lot. It might not completely disappear, but we're just into semantics here.


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"Well done, good and faithful servant; you were faithful over a few things,
I will make you ruler over many things.  Enter into the joy of your lord"
(Mt. 25:21 NKJV)

If you have not been faithful in the unrighteous mammon, who will commit to your trust to true riches?" (Lk. 16:11 NKJV)

The Apostle Paul wrote, "Now godliness with contentment is great gain. We brought nothing into the world and it is certain that neither can we take anything out. So having food and clothing we will be content with that. But those who want to get rich fall into temptation and a snare and into many foolish and harmful desires, that plunge people into ruin and loss; because the love of money is a root of all kinds of evil; in their greediness some have been led away from the faith and have impaled themselves on many distresses." (1 Tim. 6:6-10 NKJV)

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The information in these articles is the responsibility of Jay O'Keefe and Ted Spaeth, but all your decisions are your own responsibility.

This web page was last updated on 25 May 2009 .