Small Investors Fleeing Stocks as Bond Prices Soar

Jeremey Siegel, others wonder if a bond bubble is on the way

Investors are pulling out of stock mutual funds in droves, though foreign stock funds are still attracting cash. While the Investment Company Institute data shows that cash is flowing into bond funds, yields are extremely low; and some fear a bond bubble might be forming. Investors are also rebalancing their retirement account allocations from stocks (70% two years ago, according to Hewitt Associates' 401(k) Index Observations, to 49% by the beginning of 2009; now 57%, with most of the rise attributable to the increase in stock prices, not to asset allocation changes).

On Wednesday, August 18, Jeremy Siegel, professor at Wharton, explained further about the bond bubble in an interview on CNBC. Bubble warnings have been circulating for some time, although they died down early in 2010 when economic recovery indications sent people out to buy stocks and leave bonds with their low yields.

But now that the market is down again and investors are fleeing stocks and stock mutual funds, bonds are on the move again, and the warnings are sounding once more. While Warren Buffett, Nouriel Roubini, and Bill Gross had sounded the alarm earlier, Siegel and others warn of the dangers of relying too much on bonds. Some are advising against locking anything into bonds long term, since the danger of such low rates is that bondholders will be trapped, stuck with them if rates go up. Others warn about the dangers of municipal bonds if municipalities are unable to pay their debts.

Not everyone agrees that a bubble is on the way. Paul Krugman theorizes that it's tough for people to envision a long period of time with such low interest rates, and calculates why bonds may not be such a bad idea after all; Barron's also questions whether such a phenomenon exists, never mind whether it's inevitable.

All in all, the usual rules apply: proceed with caution, and do your homework.

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