Greatest bubble in a decade?

Great financial bubbles are a generational thing. The dot-com bubble lasted the entire nineties; as did the Japanese bubble a decade earlier. Are government bonds the current ‘Bubble of the Decade’?

Over the past year, bond yields have collapsed across the board. So much so that:

  • Five countries are seeing the entire yield curve below zero (August 19, Reuters) – Sweden, Denmark, Germany Switzerland, Netherlands. Other countries are quickly following suit, such as Japan.
  • $16 trillion worth of bonds are negative yielding. This is about 27% of the total outstanding amount.

Investors are not paid anything to hold the assets. In fact, they are now paying out to hold these assets. ‘Risk-free returns’ are morphing into ‘return-free risk’.

Since investors are not getting any interest from bonds, why do they still buy them? Fear, for one. Fear of recessionary economies. And fear of other assets performing worse than bonds.

Another telling sign is that this bond rally is a global phenomenal. Investors are buying bonds because others are buying them. Bonds are rallying in the US, Europe, and Asia. In the UK, for example, note the strength of the gilt ETF (IGLT). Prices are climbing rapidly into new all-time highs.

In 2017, Argentina was able to issue some ‘century’ bonds where maturities stretch out beyond 2100. Just 24 months later, its currency and stocks have crashed. According to some recent quotes, prices of these century bonds have collapsed 40 percent. This tells you the risk of these sovereign bonds.

In the absence of regular interests from bonds, investors are probably betting on price momentum alone. But price momentum, as seasoned investors know, is a volatile thing. When the last buyer is in, uptrends often reverse, sometimes quite dramatically.

In sum, while investors are enjoying great returns from government bonds, I would like to highlight the risk of joining a crowded trade. Rallies and setbacks are a recurring phenomena in financial markets. It’s no different this time.

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