| The Next Big Financial Bubble? |
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| Thursday, 01 July 2010 19:30 | |
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As Congress continues to dicker over details of the proposed Wall Street reform, there is a sideshow going on in the background that, so far, isn't getting as much attention. Reform is intended to lay new ground rules to prevent the problems of the past from reoccurring—problems like those created by derivatives, credit default swaps, and other exotic vehicles that were linked to the catastrophic housing bubble. But before reform is even finalized, some analysts are already raising concerns about the next big bubble. In our bookThe Big Gamble: Are You Investing or Speculating? we layout the whole historical landscape of financial bubbles from tulips, to dot-coms, to housing. If we were able to go back and add another chapter, we'd probably call it, The Future Bubble: Bonds. Yes, bonds may well be the next story to make financial headlines. But unlike the tech bubble of the late 90s, the bursting of the bond bubble, if indeed there is one coming, will not be preceded by exuberant tales of speculators making a killing. Bonds are the last place you'd go if you were looking for quick profits. But when stock values sink, bonds become like magnets. Consider what happened when the tech bubble burst in 2000 and equities lost almost half their value. During the following three years we witnessed corporate bonds grow by nearly 50%. More recently, during the meltdown of 2008, when baby boomers suffered big losses to their stock portfolios, their first reaction was to rush headlong into bond funds. In a most unlikely scenario, U.S. Treasury bonds, with their near-zero interest rates, were not only attractive picks, they actually turned out to be one of the few investments that stayed on a relatively even keel. Now bond funds are projected to get an infusion of about $380 billion in 2010—that's more than went into U.S. equity funds during the entire past decade. Last year alone, a record $376 billion went into bonds. And in recent weeks, because of concerns over Europe's debt problems, investors skittish about equities are rushing back into treasuries again. The belief that bonds are a safe haven continues to fuel the feeding frenzy. While it's true that bonds have historically been less volatile than stocks, the fact is they lose money just like equities do. By any measure, this much money pouring into a particular market segment tends to signal a bubble in the making . . . and the bond market might be ripe for a downfall. Despite the recent uptick in Treasury bond prices, current near-zero interest rates have nowhere to go . . . but up. The Treasury market will eventually reach critical mass and investors will no longer accept such low returns. That may force the Feds to raise interest rates sooner rather than later. When they do eventually raise rates, and naturally they will, then the prices for existing bonds with locked-in rates are going to drop. Why? Because investors will buy newly-issued bonds that pay a higher interest rate. But so far the Fed feels no pressure to raise rates or to tighten credit. Why would they? Just look around. With the economy still limping along at a slow pace, credit is still about as tight as it can get. Keep your eyes on the bond market and be aware of where you are putting your money. If you need some background or guidance on what causes a financial bubble, read our book,The Big Gamble: Are You Investing or Speculating?. You'll find plenty of good information about how to spot and avoid the next bubble, whatever it might be. |
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