The Perils of the Bond Market

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Johnny Oxygen
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The Perils of the Bond Market

The Perils of the Bond Market

There can be no greater travesty of “reporting” by the mainstream media than their failure to warn investors of the horrifying risks which accompany any investments in the bond market today. It is a greater failure than when they failed to warn investors adequately about the NASDAQ tech-bubble, and a greater failure than when they failed to warn investors about the massive U.S. housing bubble (and Wall Street Ponzi-schemes associated with that bubble).

There are two reasons why this failure outweighs even those previous episodes of catastrophic myopia. First of all, the global bond market is much larger than either the NASDAQ, or the U.S. housing market (even at their bubble-peaks) – thanks to the mountains of sovereign debt which the bankers have seduced our “leaders” into creating. Secondly, unlike those suckers in the tech-bubble or the U.S. housing market at those bubble-peaks, the chumps in today’s bond market have no possible up-side to their investment.

It’s one thing to be foolish enough to “invest” in a market at the peak of one of history’s greatest asset-bubbles. However, it requires a quantum-leap in stupidity to buy into one of history’s greatest bubbles when the only, possible direction in which that investment can go is down.

To understand the situation in the bond market properly, it’s first necessary to note a trait which is totally unique to bonds (among conventional investments). The bond market is always going “up”. When interest rates fall, and the “yield” on the bond declines, the price of that bond rises by an equal, inverse amount. Conversely, when the price of a bond falls, this automatically means that its yield rises (again by an equal, inverse amount).

I will not criticize the media for reporting on the bond market as the proverbial glass that is always “half-full”, other than to observe that it is a trait which is common to all shills. The point to be made here is that unique to all investments, bonds have a built-in “hedge”.

For conservative investors, that has always been an attractive selling point. However, what readers (and investors) must be aware of is that because bonds are perfectly hedged in this manner, this automatically greatly limits the net gain which can possibly be earned by an investor.

If the bond increases greatly in price, the yield plummets. If the yield soars, the bond-holder suffers a capital loss to eat into that gain. Indeed, under the best of circumstances bonds can only be recommended as a rational investment when there is a significant, positive (real) differential between the yield on the bond and the rate of inflation.

Any time that this yield differential is zero, or worse, negative, then bonds become a guaranteed money-loser as a long-term investment. Yes, the capital appreciation of bonds might bail out an investor under those circumstances, but that brings us to the second unique trait of bonds: a maximum price.

Buy an equity, and the theoretical gains are potentially infinite, since an infinitely profitable company could generate a theoretically infinite share price. Conversely, bonds have an absolute ceiling on their price: when interest rates approach zero.

Thanks to the Federal Reserve buying-up every U.S. Treasury in sight (because “QE I” never ended), U.S. interest rates are at their absolute lows. Short-term yields are virtually zero. And while longer-term yields are significantly higher, we now know that those interest rates are as low as they can possibly go (over any kind of longer time horizon).

We know this because “QE II” was supposed to bring down both short-term interest rates and (more importantly) longer-term rates. In fact, longer term rates have edged higher since “QE II” was announced – a clear message from the market that the Treasuries-bubble has reached its saturation point, and no matter how many Bernanke-bills “Helicopter Ben” cranks-out on his printing press, the only possible direction for U.S. interest rates is higher.

In other words, absolutely the only possible direction in which the U.S. bond market can go is lower. That brings us to the questions: how low, and how fast?

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