Ouch … Hath the Bondocalypse Descended upon Us?

Ouch … Hath the Bondocalypse Descended upon Us?

Regular readers of my blog will know that I often riff on the 10 year Treasury rates and how I feel that it spells out a “Safety Bubble”. Many investors have fled there for safety, perhaps under estimating the ugliness of price risk. If you buy a low yield bond and immediately afterward bond yields go up, then the value of your bond immediately goes down.

When the 10 year went to 1.39% a few weeks ago, I had written about how this could be the bottom (also acknowledging that there was no way to know the day nor the hour of this bondocalypse). But that if yields went up about 20 basis points to 1.59% then it would wipe out more than a year of yield.

This morning, the 10 year treasury yield is 1.81%. This has wiped out more than two years of yield in only a matter of weeks. I worry at some point that there would be a bond panic. Investors may sell and it would cause yields to go up even further. I looked at one long term bond investment this morning and it is down 10% since July 27, 2012. In the past, general wisdom was that long term bonds were relatively safe investments. Folks, the rules have (perhaps temporarily) changed.

Another past time of mine is that I mentor up and coming financial advisors. I feel that there is a great need for advisors who think differently. It is crucial that we think comprehensively about our investments and realistically about our investing environment.

Yesterday I was on the phone with one of the advisors I mentor and I strongly encouraged him to not necessarily follow the asset allocation models handed to him (these models tell you how much to invest in bonds and/or stocks) because I believed in the Safety Bubble. I told him that one of my mistakes that I felt I had made in advising clients was back in 2006 when it was widely known and whispered that we were at the height of a real estate bubble. I had looked into it and agreed … yet the asset allocation models said to put 2-5% in Real Estate investments. My decision at the time was that I wasn’t smarter than the model and that the glory of asset allocation is that it balances everything out. I was wrong. In the years following, I watched this piece of my clients’ portfolios take a severe hit as the Real Estate Bubble popped (thankfully it was a small piece). What eats me up about it is not the mere fact that it went down. I don’t feel one iota of guilt as the market experiences cyclical drops. What eats me up is that I knew better. I knew it was overpriced and that even though the textbook tells you one thing, the current day reality is something else.

I feel that today we are in such a period. Bonds, in general (it’s obviously bond specific) are overpriced. I think that they should be very carefully considered and look at, not as you’ve been raised to believe, but as they are today. The old adage is that bonds are safer than stocks. I think that we’re in a unique environment that is the exception to the rule.

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