Long-term bonds are enjoying strong yields these days, which is good news for investors. But watch out, because a painful day of reckoning is on the way, says investment strategist John Mauldin.
“Investors are barely being compensated for the risks they’re taking” with corporate bonds, for instance, Mauldin wrote in his latest viewpoint on the bond market, “Bubbles, Bubbles Everywhere.”
“One day, all the debt will come due, and it will end with a bang,” said the chairman of Mauldin Economics.
Some investors, at least in the short term, are pleased with their rewards.
The 30-year Treasury is outperforming junk bonds and the S&P 500 by a wide margin this year, Bloomberg reported Tuesday. These long-term bonds, which dropped about 15% last year, are up 17.5% in 2014.
Investors don’t seem too worried about rising rates in the immediate future, some experts suggest, because the Federal Reserve continues to trim down economic-growth expectations.
Plus, they seem content with yields of 3.2% today, despite the fact that this figure falls short of 4.1% average of the past 10 years.
While many asset classes are “looking like bubbles from our cheap seats,” Mauldin says, he is particularly concerned about the corporate bond market.”
“Average yields on investment-grade debt worldwide dropped to a record low 2.45% as we write this from 3.4% a year ago, according to Bank of America Merrill Lynch’s Global Corporate Index,” he explained.
Overall, veteran investors in high-yield bonds and bank debt “see a bubble forming,” noted Mauldin, the president of Millennium Wave Advisors and Millennium Wave Securities in Dallas.
Wilbur Ross Jr., chairman and CEO of WL Ross & Co., Mauldin adds, has gone so far as to point to a “ticking time bomb” in the debt markets.
Some $500 billion a year of this debt comes due between 2018 and 2020, Ross shares.” Government bonds are not even safe, because if they revert to the average yield seen between 2000 and 2010, 10-year treasuries would be down 23%.
“If there is so much downside risk in normal Treasuries,” riskier high yield is even more mispriced, Ross said. “We may look back and say the real bubble is debt.”
What’s leading to bubbles these days? The economy is weak, and inflation is low, Mauldin argues. “The growth in the money supply doesn’t go to driving up prices for goods like toothpaste, haircuts, or cars. It goes to drive up prices of real estate, bonds, and stocks.”
Again, he zooms on the bond market, quoting Dallas Fed President Richard Fisher: “We have a hyper-robust bond market right now,” and the credit-market jump has him concerned about a new destabilizing credit boom.
“You don’t sit on a hot stove twice,” Fisher added.
Cullen Roche, who heads the San Diego-based RIA Orcam Financial Group, is more sanguine about the fixed-income situation.
“I’ve been debunking the U.S. government ‘bond bubble’ story for over four years now, so you’ve probably read some version of this over the years,” he explained Saturday in a blog.
Still, Roche admits, this doesn’t mean bonds “aren’t potentially overpriced—especially junk bonds and some other corporate bonds that have benefited from the chase for yield induced by the Fed.”
His main point, though, is to object to use of the term “bubble” when discussing government bonds; bubble implies an “extraordinarily overpriced market susceptible to tremendous downside,” Roche adds. “Frankly, I don’t think Treasury Bonds look remotely similar to something like the NASDAQ.”
Also, he explains, debt doesn’t actually all come due at one time: “In a credit-based monetary system it’s actually impossible for all of the debt to come due because that would actually eliminate most of the money we use.”
There are, however, broad concerns about the growing amount of U.S. debt and its impact on economic growth.
BlackRock experts, for instance, said recently that with government debt growing from $4.5 trillion in 2007 to $12.6 trillion today, the credit level acts as a drag on the domestic economy.
For the moment, though, investors are sticking with bonds, thanks to their performance, which appears to be benefiting from weak economic growth.
In a report issued Wednesday, LPL Financial (LPLA) investment strategist Anthony Valeri says bonds just posted another weekly gain, “due mostly to late week strength on the latest round of geopolitical fears.”
He also says that after the initial lift to bond prices from the Crimean Crisis faded, weak domestic economic data during the first quarter of 2014 “helped support bonds.”