Gus Sauter Worried About "Bond Bubble"

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Munir
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Gus Sauter Worried About "Bond Bubble"

Post by Munir »

If this was posted previously, it can be deleted.

The following is a quote from an AP Q&A with Gus Sauter pulished in the business section of our local paper today under a "focus" heading:
"Q: are bond investors facing a significant risk?

Sauter: Unfortunately, we may be seeing the bond market's version of 1999 and the run-up of tech stocks. We're building a pretty big bubble in the bond market and bubbles just don't end pleasantly. A lot of investors could be disappointed. When the economy starts to strengthen, interest rates will go back up and bond returns will be disappointing, even negative."
While he may be technically correct, the doom & gloom tone is suprising . He also does not propose any alternatives or advice on what investors should be doing in the fixed income sector, nor anything about duration and possible eventual recovery of bond funds if interest and dividends are re-invested.
ataloss
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Re: Gus Sauter Worried About "Bond Bubble"

Post by ataloss »

bonds are not cheap but if he has has some good ideas about how to react it would be nice to hear them.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by athrone »

ataloss wrote:bonds are not cheap but if he has has some good ideas about how to react it would be nice to hear them.
If you have 50% or more of your portfolio allocated to a single asset (such as US bonds or bond-like investments), you are probably susceptible to asset bubbles. The solution would be to reduce any such allocations in order to minimize the risk of said bubbles.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by LadyGeek »

This topic is now in the Investing - Theory, News & General forum.
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Langkawi
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Re: Gus Sauter Worried About "Bond Bubble"

Post by Langkawi »

Here's the article. It's actually a month old.
http://bigstory.ap.org/article/vanguard ... ond-bubble
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Re: Gus Sauter Worried About "Bond Bubble"

Post by leo383 »

ataloss wrote:bonds are not cheap but if he has has some good ideas about how to react it would be nice to hear them.
After it pops, there will be a lot of people with advice. :)
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Re: Gus Sauter Worried About "Bond Bubble"

Post by nisiprius »

Munir wrote:Sauter: Unfortunately, we may be seeing the bond market's version of 1999 and the run-up of tech stocks. We're building a pretty big bubble in the bond market and bubbles just don't end pleasantly. A lot of investors could be disappointed. When the economy starts to strengthen, interest rates will go back up and bond returns will be disappointing, even negative."
Ugh. Well, he said what he said.

From 1997 to 2000, the NASDAQ Composite grew almost fourfold, then fell 75% from 2000 to 2002. When he refers to the bond market's version of 1999 and the run-up of tech stocks," what does he mean by that and what does he expect people to take from that?

The original "bubble," the South Seas Bubble, involved an eightfold runup from 1719 to 1720, and a 90% fall from 1720 to 1721.

The uranium bubble of 2007 involved more than a tenfold runup from 2005 to 2007, and a 70% fall from 2007 to 2010

Does Sauter really think bonds are priced four or eight times what they're worth? That they are going to fall 70%, 75%, or 90%?
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Noobvestor
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Re: Gus Sauter Worried About "Bond Bubble"

Post by Noobvestor »

nisiprius wrote:
Munir wrote:Sauter: Unfortunately, we may be seeing the bond market's version of 1999 and the run-up of tech stocks. We're building a pretty big bubble in the bond market and bubbles just don't end pleasantly. A lot of investors could be disappointed. When the economy starts to strengthen, interest rates will go back up and bond returns will be disappointing, even negative."
Ugh. Well, he said what he said.

From 1997 to 2000, the NASDAQ Composite grew almost fourfold, then fell 75% from 2000 to 2002. When he refers to the bond market's version of 1999 and the run-up of tech stocks," what does he mean by that and what does he expect people to take from that?

The original "bubble," the South Seas Bubble, involved an eightfold runup from 1719 to 1720, and a 90% fall from 1720 to 1721.

The uranium bubble of 2007 involved more than a tenfold runup from 2005 to 2007, and a 70% fall from 2007 to 2010

Does Sauter really think bonds are priced four or eight times what they're worth? That they are going to fall 70%, 75%, or 90%?
I would hope he is a reasonable enough man (seemed that way when I met him, briefly!) to have meant 'a bond-scale equivalent' as in: maybe a 10-15% drop in NAV. In short, I presume if pressed about this he would elaborate, and not sound so ... well, unrealistic, hyperbolic, incorrect, take your pick. Of course, it's not just degree but speed that are the issue with the comparison - rate would have to rise really fast (or governments would have to start defaulting, I suppose) for a typical bond fund (with some corporates, some treasuries, and mostly of intermediate duration) to drop even that much over a short period. Sigh. It's hard to help him out of this one, but I hope he would help himself if asked about it again.

If bonds are set to drop 70-90%, I think it's time to stock up on the classics: guns, ammo, food, water, shelter, gold, w/e.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by Jack »

This article is a sure sign that the word "bubble" has entered a bubble. Paraphrasing Gus, a lot of writers may find the word's usefulness is disappointing or even negative in value. I am unwilling to speculate as to the limits of hyperbole that this word may soar before bursting and disappearing from use.

A bubble implies widespread speculation in which prices increase well beyond intrinsic worth and speculators only hope of profit is finding another speculator willing to pay a higher price. There is no limit to the speculative price as each speculator tries to find a greater fool.

There is no widespread speculation on bond prices because yields can't go below zero and therefore there are fixed limits to prices. There are no bond speculators out there scooping up bonds because they think they can flip them by selling them at higher prices to another speculator. Prices simply can't go much higher at this point.

Bonds have a precisely known income stream and a precisely known value at maturity. Speculative assets have no maturity at which value is known and no known value other that what some else is willing to pay. The only way to get cash is to find another speculator. Speculative assets values can go to zero. Bonds have a face value that is paid at maturity.
Last edited by Jack on Tue Jan 15, 2013 6:42 pm, edited 1 time in total.
Levett
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Re: Gus Sauter Worried About "Bond Bubble"

Post by Levett »

What did Sauter say? (It's irrelevant what I think.)

He said: "When the economy does start to strengthen, interest rates will go back up and bond returns will be disappointing, even negative."

"disappointing, even negative" is what he said.

"Does Sauter really think bonds are priced four or eight times what they're worth? That they are going to fall 70%, 75%, or 90%?"

No. That's not what he said--whatever one may think of what he said.

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Re: Gus Sauter Worried About "Bond Bubble"

Post by nydad »

"There is no widespread speculation on bond prices because yields can't go below zero and therefore there are fixed limits to prices" - actually this isn't strictly true. This year, germany sold bonds with a negative yield.

http://online.wsj.com/article/SB1000087 ... 70554.html

I'm not sure I understand the behavior of investors who bought those however. I assume it's some sort of currency hedging strategy. Otherwise, if you're all in one currency, why not just keep it safely tucked away in a bank account?
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Re: Gus Sauter Worried About "Bond Bubble"

Post by TS1 »

nydad wrote: ...why not just keep it safely tucked away in a bank account?
For large amounts, government bonds are safer than a bank account.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by nydad »

Interesting - is that b/c of institutional risk of the bank itself (vs. the government guaranteeing payments)? In that case, I guess this is a case of institutional investors who buy german debt vs hold cash in their bank and pay a small premium for the privilege?

(edited) - just read some more about negative interest rates - take a look at this:
http://www.ft.com/cms/s/0/097dd146-4623 ... z2I61uCDym
http://online.wsj.com/article/SB1000087 ... 16440.html

In any case, if interest rates do go negative, those holding 5 year notes at 1% will be kings! :)
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Re: Gus Sauter Worried About "Bond Bubble"

Post by brick-house »

levett wrote:
What did Sauter say? (It's irrelevant what I think.)
+1

Longer article quote shows Gus Sauter stating a 10 yr expectation 0f 6-9% for stocks and 2-3% for Bonds. Pretty common stock bug outlook. :beer

http://bigstory.ap.org/article/vanguard ... ond-bubble

Q: We're almost at 2013, but what's your outlook for the stock market, say over the next 10 years?

A: The best predictor of future returns is what you're paying for earnings. And valuations now are quite reasonable. (Eds note: Stocks in the S&P 500 are trading at an average of about 14 times earnings over the past 12 months, below the 10-year average of about 15). So stocks are a bit cheap, and you can expect a reasonable return over the next decade — maybe 6, 7, 8 or 9 percent a year, something in line with the historic average.

Corporate earnings are the key factor to look at. Lots of people make the mistake of thinking stock returns are tied to economic strength. But the data don't corroborate that. And the interesting thing about corporate profits is that they are blind to national boundaries. More and more, companies are global, and earnings growth is really independent of the strength of one country's economy.

Q: What about the outlook for bonds?

A: The best predictor is the current yield to maturity. The yield now on a 10 year Treasury bond is a little under 2 percent. So you might expect 2 to 3 percent a year from a bond portfolio. That's if you include some higher-yielding bonds where's there's greater credit risk than in the Treasury market. Two to 3 percent is certainly less than we have experienced historically from bonds, and it's significantly less than what we've seen over the last 30 years of a bull market for bonds.

Q: Investors have added more than $1 trillion in cash to bond funds since the 2008 financial crisis. What's the risk for investors who have moved much of their portfolio into bonds?

A: I'm worried. In some cases, these investors have been seeking yield, and in other cases they've been pursuing an investment they consider to be much safer than the stock market. Unfortunately, we may be seeing the bond market's version of 1999 and the run-up of tech stocks in the stock market. We're building a pretty big bubble in the bond market and bubbles just don't end pleasantly. A lot of investors could be disappointed. When the economy does start to strengthen, interest rates will go back up and bond returns will be disappointing, even negative.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by pascalwager »

I think Sauter was concerned about investors who have increased their bond AA/maturity in the attempt to increase income or further reduce risk. Also, he seems to oppose high bond AA's. That's my impression from recent interviews.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by grap0013 »

Well how did bonds get so bubbley? Decling interest rates, low inflation, and capital gains from increased buying demand. I could easily see the reverse occuring with rising interest rates, high inflation, and bond prices falling. This could easily get you some real returns in the short term in the minus 10-15% range. Relative to their normal standard deviation that is a big drop.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by midareff »

nisiprius wrote:
Munir wrote:Sauter: Unfortunately, we may be seeing the bond market's version of 1999 and the run-up of tech stocks. We're building a pretty big bubble in the bond market and bubbles just don't end pleasantly. A lot of investors could be disappointed. When the economy starts to strengthen, interest rates will go back up and bond returns will be disappointing, even negative."
Ugh. Well, he said what he said.

From 1997 to 2000, the NASDAQ Composite grew almost fourfold, then fell 75% from 2000 to 2002. When he refers to the bond market's version of 1999 and the run-up of tech stocks," what does he mean by that and what does he expect people to take from that?

The original "bubble," the South Seas Bubble, involved an eightfold runup from 1719 to 1720, and a 90% fall from 1720 to 1721.

The uranium bubble of 2007 involved more than a tenfold runup from 2005 to 2007, and a 70% fall from 2007 to 2010

Does Sauter really think bonds are priced four or eight times what they're worth? That they are going to fall 70%, 75%, or 90%?


Nisi,

Would that be a 1.6% 10 year treasury (going to only) 6.4% ?? or perhaps a .75% 5 year treasury going to 3% .. is that really a stretch?
Last edited by midareff on Wed Jan 16, 2013 9:51 am, edited 1 time in total.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by garlandwhizzer »

I think Sauter is exactly correct and that a long (more than a decade) and very unpleasant bear market in bonds is soon to start. That said, a bear market in bonds means zero or perhaps slightly negative REAL return probably for a decade or more, not the roller coaster ride of equities. Also, although it is clear that when the economy starts growing substantially and inflation heats up, bonds will suffer relative to stocks, no one can accurately predict exactly when that will happen. A bond allocation is still necessary to diversify and stabilize a portfolio, bear market or not, but perhaps the "age in bond" asset allocators should take a hard look at their asset allocations and decide whether their asset base can sustain zero or negative real returns for over a decade which I believe is a probable outcome. Personally although I'm retired and 65, my current bond allocation is 30% and I'm considering dropping it to 25%, based on probable projections of the differences in long term returns between equities and bonds over the next decade or two.

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Re: Gus Sauter Worried About "Bond Bubble"

Post by jburdette »

midareff wrote:Would that be a 1.6% 10 year treasury (going to only) 6.4% ?? or perhaps a .75% 5 year treasury going to 3% .. is that really a stretch?
I'm not sure how you got your numbers... The numbers you quoted would mean a 35% drop for the 10 year and a 10% drop for the 5 year.

If I've calculated correctly, a 70% price drop on the 1.6% 10 year treasury would be from interest rates instantly rising to 15.7%. For the 5 year, rates would have to rise to 27.14%.
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Re: Gus Sauter Worried About "Bond Bubble"

Post by BlueEars »

Here is my attempt to put some numbers on a 7 year bond scenario with a 3 year rate rise. The funds are Total Bond Market and Short Term Investment Grade. Note the months of annual negative returns. The final CAGR's being equal is interesting.

Image
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Re: Gus Sauter Worried About "Bond Bubble"

Post by Levett »

Like Mr. Sauter, it appears the Fed itself is getting anxious about "overheating" in the bond market, among other places.

The following from Bloomberg strikes me as an important elaboration of Mr. Sauter's concern:

http://www.bloomberg.com/news/2013-01-1 ... uying.html

Lev
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