Is The Bond Market Predicting A Crash?

| August 24, 2010 | 0 Comments

The financial experts are predicting doom.

Lately, the media is pulling out big scary names to describe the markets. There are some really colorful terms floating around.

It’s the Hindenburg Omen!  It’s the dreaded Death Cross!  Wow.  I guess we should all run for the hills…

Clearly this terminology is meant to terrify us about the coming financial apocalypse.

You know what I think… It’s all a bunch of baloney.

Let me tell you what I think…

You can put all of your money into cash and wait for a crash.  Or you can keep your money in the financial markets and profit as the economy improves.

Look, I’m not saying we’re at the cusp of a major rally… or at the edge of a crash.  But let’s maintain some composure.  What we really need to do is consider the facts.

So let’s take a closer look at the bond market.

In my opinion, the bond market is the best overall gauge of our economic well-being.  Bond traders tend to have a strong grasp of the big picture. What’s more, bond traders are always monitoring expectations and economic data.  Because of this, bond prices are often forward looking.

But wait… have you seen the 10-year bond lately?

10-year yields are at their lowest point since March 2009.  That’s back when the financial markets were in turmoil.  And some were predicting the end of the banking system as we know it.

Bonds offer about a 2.50% annual rate… for 10 years!  You could probably throw darts at a Wall Street Journal and pick an investment with a higher yield than that!

By the way, remember what happened in 2009, the last time yields got this low?

Nothing.

As a matter of fact, the world didn’t end.  Pandemonium didn’t erupt in the streets.  American Idol wasn’t even cancelled.

So why are bonds once again trading at such a low yield?  Are bond traders also predicting a crash?

The last time yields were this low there was a legitimate risk of a global financial meltdown.  The banking system was in huge trouble.  The government had to step in to save several major financial institutions. Plus, real estate prices were plummeting with no end in sight.

But this time around, things are different.

Yes, real estate and the job market are still issues.  But… they haven’t gotten any worse.  In fact, there have been some small steps towards improvement.

More importantly, the major banks are healthy.  They’ve been forced to eat their losses.  The Fed has supplied them with huge reserves of cash. And, they’ve cut costs and increased profits.

I don’t know about you, but it hardly seems like our financial system is about to fail.

So then, why are bond yields so low?

Something else must be going on in the bond market.

First off, there’s the unusual situation of excess liquidity.  Central banks across the globe are printing money to combat deflation.  And large banks are sucking up this excess cash.

Here’s the thing… the banks aren’t loaning the money back out.  Instead they are investing it in super safe assets… like Treasury bonds.

But it’s not just liquidity driving bonds higher.

There’s also the issue of foreign government risk.  Normally, government bond investments get spread out across the globe.  But even some of the historically safest governments are dealing with questions of creditworthiness.  Europe is a leading example of this situation.

So by default, all the money is flowing into U.S. Treasuries.  Even with all of the economic issues, the U.S. still has the biggest economy and the safest bonds.

Here’s another theory about the low bond yields…

Nobody has any better investment ideas.

Look at the alternatives.

In recent weeks, equities are lagging.  Real estate is still stagnant. Commodities are volatile.

Investors don’t know where to turn.  For lack of any better ideas, they dump their money into Treasuries.  Boring maybe, but secure.

Don’t get me wrong…

I don’t think bonds are in a bubble.  You need to have rampant enthusiasm to create a bubble.  Like the way internet stocks were going up in the late 90’s.  As far as I can tell, no one is all that enthusiastic about earning 2.5% a year in bonds.

On the other hand, I do think Treasury yields will slowly start to increase.  It just may take a few months.

But here’s the key point…

I don’t think we’re headed for a crash.  The fundamentals of the economy are bad, but not THAT bad.

In general, big companies are still doing pretty well.  What’s more, the financial system is flooded with cash.  Major banks simply won’t fail with this kind of liquidity.

It’s not a bad idea to keep some of your money in cash or Treasuries.  But don’t be afraid to invest in the equities market.  You’ll be glad you did as the economy improves.

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Category: Bonds

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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