The Treasury-bubble meme

By Felix Salmon
August 18, 2010
Barry Ritholtz says so explicitly, while Jeremy Siegel and Jeremy Schwartz lay out the, um, logic:


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It’s something of an emerging meme: Treasuries are the new dot-com stocks. Barry Ritholtz says so explicitly, while Jeremy Siegel and Jeremy Schwartz lay out the, um, logic:

Ten years ago we experienced the biggest bubble in U.S. stock market history—the Internet and technology mania that saw high-flying tech stocks selling at an excess of 100 times earnings. The aftermath was predictable: Most of these highfliers declined 80% or more, and the Nasdaq today sells at less than half the peak it reached a decade ago.

A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds…

The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout…

The possibility of substantial capital losses on bonds looms large. If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4% as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?

I’m sympathetic to the Jeremys’ underlying idea, but this argument is utter nonsense.

For one thing, a drop of 80% in a stock price is not in any way similar to a drop of 3% or even 9% in a bond price. And with Treasury bonds, no matter how much they cost, you’re always guaranteed to get back more money than you paid for them — all you need to do is hold them to maturity.

It’s simply untrue to say that the 10-year TIPS “is currently selling at more than 100 times its projected payout”, and it’s silly and specious to use that number to try to imply that the security looks like some latter-day Juniper Communications.

And note the rhetorical sleight of hand that the Jeremys manage to hide in that final paragraph: they start by talking about capital losses if rates rise sharply over the course of just one year, and then say that they have no doubt that rates will rise “over the next two decades”. (They also fail to explain why retiring baby boomers mean higher interest rates: I see no evidence that countries with “enormous government entitlement programs” have higher rates than those without them.)

Treasury yields are indeed low right now, but that’s largely because the economy is weak. Most bond investors would love nothing more than for the Jeremys to be proved right and for stocks to start rising impressively as the economy recovers — even if that means losing money on their bond investments. But if the economy gets worse, having your money in safe Treasury bonds is going to help you sleep a lot better than having it in risky and volatile stocks.

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