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Bond Bubble Debate Bubbles Over

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Long-term investors and those seeking safety not found these days in the stock markets have been fleeing to bonds, giving rise to speculation about a “bond bubble.” As experts weighed in on the discussion, additional aspects of the bond market surfaced as railroad operator Norfolk Southern issued bonds with a 100-year maturity date, making long Treasury bonds (30-year term) look like striplings. [After clicking on bond link, scroll down to "In the Year 2110."]

Such extra-long-lived methods of financing improvements are, of course, far from new. A group of bonds sold just a few years after the Civil War ended finally approached maturity beginning in 2009. The bonds were sold to finance a road (formerly Central Avenue and now known as Jerome Avenue) to a race track at Jerome Park (long since defunct and replaced by a reservoir), both built by Winston Churchill’s grandfather, Leonard W. Jerome.

After 135 years of dividends, paid first by the towns of Morrisania and West Farms, then by the City of New York once those towns were subsumed into the larger entity, one of the bonds matured in 2009. Of course, some of those bonds are just coming into their middle years, and will continue to pay dividends until 2147. And they’re not the oldest active bonds out there – Britain has issued “perpetual” bonds, known as consols, which are not likely ever to be redeemed, thanks to their low interest rates, and pay dividends “forever.”

First issued in 1851, consols (for “consolidated annuities“) have been popular and useful. Now the idea is being floated that the U.S. should consider issuing its own consuls, as a means of saving taxpayer money.

Fascinating as such antiquity may be in the bond market, it underscores one of the primary reasons people buy bonds in the first place: dividends. By the time those aforementioned “ancient” Jerome Park bonds have all matured, the city will have surrendered to their holders over $1 million in interest – not bad for bonds originally sold to finance a debt estimated at the heady sum of $278,000.

According to a new white paper from GMO, LLC, “A Man from a Different Time,” released August 24, investors (and their advisors, of course) ought to consider European dividend swaps. Another GMO white paper, “New World Bond Management: A Practical Framework for Decision Making,” released August 26, offers some graphic comparisons of the role that bonds play in offsetting equities volatility in a balanced portfolio, as well as explanations of how bonds function in specific strategies such as foreign bond and currency diversification and beta benchmarking.

Experts may be divided on the issue, but most still seem to be coming down on the side of bonds as a prudent investment; they point out that steady dividend income is still something to be desired. Another issue is the investor’s expectations, something that occasionally need to be managed. Yet another is the question of whether the proper type of bonds is being purchased to serve a purpose aligned with its function.

Once all these factors are taken into account, perhaps the bubble is in the eye of the beholder.


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