Greenspan: we've got a bond bubble, Houston

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Browser
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Greenspan: we've got a bond bubble, Houston

Post by Browser »

In two television interviews in recent days, Greenspan said interest rates could shoot higher and derail the economy when the bubble bursts.

The former Fed chairman says the current situation in the bond market is comparable to what happens in the stock market during an equity bubble.

Greenspan said it was appropriate to be very afraid of the bubble. He said the bond market price-to-earnings ratio was at an “extraordinary unstable position.”
http://www.marketwatch.com/story/greens ... 2015-08-19

Me, I've gone to the "no bonds" portfolio as I wrote about in another thread. CDs and Cash for me. Not sure if this is the time to "buy and hope" at least as far as bonds are concerned.

I suppose we'll have to endure the inevitable Greenspan-bashing in the thread, but it would be refreshing to dispense with that if possible. :happy
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Grt2bOutdoors
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Re: Greenspan: we've got a bond bubble, Houston

Post by Grt2bOutdoors »

I didn't read the article, how does he propose we "deflate" this bond bubble? The easiest way to deflate it is to raise interest rates in a marked and measurable manner over a period of years, even say 10 years. But do it already, because to wait any longer is causing serious mis-allocation of capital in the economy causing huge bubbles in sectors like biotechnology, the oil industry, the financial industry where they still have not learned their lesson from the 2008 mess. The people who pay are those in the real economy.
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frugalecon
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Re: Greenspan: we've got a bond bubble, Houston

Post by frugalecon »

One thing I don't understand about those calling a bubble is why they seem to assume that it is impossible for rates to simply bounce around in a narrow range for an extended period of time. Rates rose significantly from 1960 to the early 80s, and they then fell back, undoing the rise and returning to roughly the levels that prevailed in the mid 1950s. In the first half of the 20th century, rates fluctuated much less dramatically. Perhaps we are just back to a period like that. Maybe the 10 year will largely bounce around between 2 and 3% over the next twenty years. The bubble callers seem to put zero probability on that happening.
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nisiprius
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Re: Greenspan: we've got a bond bubble, Houston

Post by nisiprius »

As always, I wish the people saying we should be "very afraid" of a bond bubble would say who, exactly, should be "very afraid?" Retail investors in an ordinary "core" bond fund, intermediate-term, investment-grade, like Vanguard Total Bond? Because they are scaring those people.

I wish they would say what, exactly, in percentage dollar loss, we are supposed to be "very afraid" of? Losing half our money, like we could in stocks? Or losing 5%, which we could have avoided by just putting it in the bank, a bummer to be sure but nothing to lose sleep over.

I wish they would say whether the loss we should be afraid of is a temporary loss with recovery within the period suggested by the fund's duration, or not--and if not, why not?

And, desperately I want to know what the heck he means by "comparable to what happens in the stock market during an equity bubble." Comparable how?

Let's say we're just eyeballing the share price (i.e. the principal or capital, as opposed to the income) for Vanguard Total Bond. For the sake of argument, let's say it might be +10% above what it should be. After all, the price per share was $10 when the fund was launched in 1986.

Source: Morningstar

Image

How is this "comparable" to an equity bubble? Here, the share price for Total Bond (green) is plotted on the same scale as QQQ, the ETF that tracks the NASDAQ-100 (orange). I don't see the two as "comparable" in any way.

Image

And finally, as you can see from my snarky annotations... is this different from what already happened once, in 2010, and if so, how? In 2010, Jeremy Siegel and Jeremy Schwartz warned of a "Great American bond bubble" that was "similar" to the Nasdaq bubble, but "may have far more serious consequences for investors." It would happen "If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%" in scenario, 4% in another. In fact it did rise to 3.71%, well into the range they warned about. The chart shows what happened. (I actually emailed Professor Siegel to ask whether or not this met the conditions he predicted would have more serious consequences than the Nasdaq collapse, but he did not reply).

So, what are we supposed to be "very afraid" of? Another 2010-2011?
Last edited by nisiprius on Wed Aug 19, 2015 4:36 pm, edited 4 times in total.
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theunknowntech
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Re: Greenspan: we've got a bond bubble, Houston

Post by theunknowntech »

Browser wrote:I suppose we'll have to endure the inevitable Greenspan-bashing in the thread, but it would be refreshing to dispense with that if possible. :happy
Unfortunately it will not be possible. 3.. 2.. 1..

It's a credibility issue, looking at the history of what's been said and done in the past.
Busting Myths
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Re: Greenspan: we've got a bond bubble, Houston

Post by Busting Myths »

Browser wrote:
In two television interviews in recent days, Greenspan said interest rates could shoot higher and derail the economy when the bubble bursts.

The former Fed chairman says the current situation in the bond market is comparable to what happens in the stock market during an equity bubble.

Greenspan said it was appropriate to be very afraid of the bubble. He said the bond market price-to-earnings ratio was at an “extraordinary unstable position.”
http://www.marketwatch.com/story/greens ... 2015-08-19

Me, I've gone to the "no bonds" portfolio as I wrote about in another thread. CDs and Cash for me. Not sure if this is the time to "buy and hope" at least as far as bonds are concerned.

I suppose we'll have to endure the inevitable Greenspan-bashing in the thread, but it would be refreshing to dispense with that if possible. :happy
What the heck is a bond p/e ratio? Does he mean a bond yield? if so, take the historical REAL bond yields and compare them to current real rates in the market. Are we at historical extremes?
Ki_poorrichard
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Re: Greenspan: we've got a bond bubble, Houston

Post by Ki_poorrichard »

"If interests rates go to zero and all the governments in the world print money like crazy and prices go down - of course I'm confused. Anybody who is intelligent who is not confused doesn't understand the situation very well. If you find it puzzling, your brain is working correctly." - Charlie Munger

I could not agree more :? ...
"We are never certain. We are always ignorant to some degree." - Peter L. Bernstein
longinvest
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Re: Greenspan: we've got a bond bubble, Houston

Post by longinvest »

Ha! ha! ha! ha!...! HA! HA! HA! HA! HA!
HAHHHHHHHHHH! Ha!
Bond Bubble! HA! HA! HA! HA! HA! HA!
HA! HA! HA! HA! HA!

BUBBLE! BOOOOOND BUBBLE! HA! HA! HA! HA! HA! HA!

OK, guys. A little mathematics lesson.

The current make up of Vanguard's Total Bond Market index ETF (BND) is as follows:

Maturity / Percent-of-assets
0-1 Year: 1%
1-3 Years: 26%
3-5 Years: 21%
5-10 Years: 35%
10-20 Years: 4%
20-30 Years: 12%
30+ Years: 1%

Let's assume that your worst fears come true: yields increase by 2% tomorrow all across the yield curve, even in the long end. That's really an end-of-the-world scenario.

Tell me! Tell me! What would happen to the NAV of BND?

Actually, it's easy to (grossly) estimate using simple mathematics: we just need to compute the cumulative losses for the bonds in BND.

We know that the approximate drop in price of a bond is equal to its duration for each 1% increase in yield. A gross estimate, for a 2% increase, is 2 times the duration. (The loss, for the second 1%, should be less than the original duration, but, hey, it's better to overestimate the loss than underestimate it).

0-1 Year: average duration = 0.5 year. Loss = (2 X 0.5)% X 1% = 0.1%
1-3 Years: average duration = 2 years. Loss = (2 X 2)% X 26% = 1.04%
3-5 Years: average duration = 4 years. Loss = (2 X 4)% X 21% = 1.68%
5-10 Years: average duration = 7.5 years. Loss = (2 X 7.5)% X 35% = 5.25%
10-20 Years: average duration = 15 years. Loss = (2 X 15)% X 4% = 1.2%
20-30 Years: average duration = 25 years. Loss = (2 X 25)% X 12% = 6%
30+ Years: average duration = 50 years. Loss = (2 X 50)% X 1% = 1%

Total = 16.27%

So, BND would immediately loose at most 16%, but, and that's the thing, all of its bonds would also immediately start yielding an additional 2%! Can you imagine! Yay!

There you go!


HA! HA! HA! HA! HA!
BOOOOOND BUBBLE! HA! HA! HA! HA! HA! HA!

Thanks for making my day! :happy :happy :happy :happy
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dbr
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Re: Greenspan: we've got a bond bubble, Houston

Post by dbr »

Grt2bOutdoors wrote:I didn't read the article, how does he propose we "deflate" this bond bubble? The easiest way to deflate it is to raise interest rates in a marked and measurable manner over a period of years, even say 10 years. But do it already, because to wait any longer is causing serious mis-allocation of capital in the economy causing huge bubbles in sectors like biotechnology, the oil industry, the financial industry where they still have not learned their lesson from the 2008 mess. The people who pay are those in the real economy.
Right, applying the concept of bubble to bonds relates to economic effects not to the possibility that the assets we hold in bonds will crash.
longinvest
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Re: Greenspan: we've got a bond bubble, Houston

Post by longinvest »

Just in case anybody cares about my gross estimate of durations in my previous post, if you take the time to calculate the average duration of BND using my simplistic approach, you get 8.09 years, overestimating BND's average duration by more than 2 years. So, the immediate loss has to be even smaller than what I calculated.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Browser »

I listened to his two interviews and he basically says that "normal" interest rates have always been in the 4% - 5% area for milennia, going back to ancient Greece even; these rates must be "programmed into" human preferences. So, he sees rates reverting back to these levels, perhaps violently, and even overshooting. His comment about turning bonds around into a sort of P/E ratio is to look at the price of bonds relative to their current interest rates. He argues that this ratio, if we were looking at stocks, would be quite alarming right now - meaning that bonds are greatly overvalued. At least that's my translation of what he had to say. You can click in the interviews in the original post to hear for yourself - they are both pretty short.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Northern Flicker »

I think it would be prudent not to go to far out on the yield curve in bond investments. As an example, VG intermediate-term treasury fund has a yield about 1.6% and a duration of 5.3 years. If yields were to normalize as Greenspan suggests, this yield would rise to about 4.6%. If it did that aggressively, it might take 3 years (I personally don't think a 300 basis point rise in 3 years is in the cards, but the example is useful).

In this scenario, principal value falls about 16% and you get about 5% in interest. So even in this moderately extreme example, your bond portfolio is only down about 11%. But if the economy is strong enough to support those interest rates, it should be good news for equities.

The scenario where there is a rapid spike in rates and equities flounder or fall would be a big spike in inflation. It thus might make sense to diversify nominal bond holdings with some TIPs, maybe 25% short-term TIPs and 75% intermediate bonds. This reduces duration risk, but also lowers yield. The same back of the envelope estimate would put this allocation down about 9% if rates rise 300 bp's in 3 years, and inflation is stable.

Long-term bonds could see a fall similar in magnitude to a bear market in equities with rising rates, but it is hard to see that with shorter duration instruments.

-jalbert
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Re: Greenspan: we've got a bond bubble, Houston

Post by Browser »

The scenario where there is a rapid spike in rates and equities flounder or fall would be a big spike in inflation.
I don't see why this would be true. The causal order is usually the reverse: a spike in inflation followed by a rise in rates. I think Rick wrote about this a while back, pointing out that we could have a spike in rates without an accompanying spike in inflation and that TIPs carry this kind of risk. If Greenspan's thesis is correct and that ZIRP has artificially suppressed rates, it might make sense that rates could mean-revert without an uptick in inflation.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Grt2bOutdoors »

Browser wrote:
The scenario where there is a rapid spike in rates and equities flounder or fall would be a big spike in inflation.
I don't see why this would be true. The causal order is usually the reverse: a spike in inflation followed by a rise in rates. I think Rick wrote about this a while back, pointing out that we could have a spike in rates without an accompanying spike in inflation and that TIPs carry this kind of risk. If Greenspan's thesis is correct and that ZIRP has artificially suppressed rates, it might make sense that rates could mean-revert without an uptick in inflation.
There is no inflation now, there will be no meaningful rise in inflation over the next 2-3 years. Why do I say that? We have falling commodity costs across the spectrum - metals, oils, agriculture that will translate into lower input costs, wages are being held down by slack demand and an oversupply of labor (never mind businesses are crowing about lack of skilled labor - that is just noise). At best, it will take 2-3 years to work through the oversupply on the commodity side, even then unless the consumer comes back in rip-roaring fashion demand for goods and services is not going to overshoot their supply. Higher interest rates will temper the demand for financial products such as home equity loans, consumer loans, credit cards, debt issuance for frivolous stock buybacks, etc. The Fed is going to be behind the curve if they don't start raising rates and soon.
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Browser
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Re: Greenspan: we've got a bond bubble, Houston

Post by Browser »

Grt2bOutdoors wrote:
Browser wrote:
The scenario where there is a rapid spike in rates and equities flounder or fall would be a big spike in inflation.
I don't see why this would be true. The causal order is usually the reverse: a spike in inflation followed by a rise in rates. I think Rick wrote about this a while back, pointing out that we could have a spike in rates without an accompanying spike in inflation and that TIPs carry this kind of risk. If Greenspan's thesis is correct and that ZIRP has artificially suppressed rates, it might make sense that rates could mean-revert without an uptick in inflation.
There is no inflation now, there will be no meaningful rise in inflation over the next 2-3 years. Why do I say that? We have falling commodity costs across the spectrum - metals, oils, agriculture that will translate into lower input costs, wages are being held down by slack demand and an oversupply of labor (never mind businesses are crowing about lack of skilled labor - that is just noise). At best, it will take 2-3 years to work through the oversupply on the commodity side, even then unless the consumer comes back in rip-roaring fashion demand for goods and services is not going to overshoot their supply. Higher interest rates will temper the demand for financial products such as home equity loans, consumer loans, credit cards, debt issuance for frivolous stock buybacks, etc. The Fed is going to be behind the curve if they don't start raising rates and soon.
It's good to finally meet someone with a working crystal ball. But as soon as the information gets out that there will be no inflation for the next few years everyone will be hanging onto their bonds and buying more. How will I make any money then? What I think is that it might be better to take the other side of that trade and get the heck out of bonds while you and everyone else are buying and holding. Then, if your crystal ball has lied to you, I'll be buying your bonds later at much lower prices and much higher interest coupons. :mrgreen: :D
We don't know where we are, or where we're going -- but we're making good time.
nukewerker
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Re: Greenspan: we've got a bond bubble, Houston

Post by nukewerker »

So what happens when people rotate out of bonds? How do you know what the discount will be? Particularly if rates go up and you can put money in a savings account and not risk losing 16%.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Grt2bOutdoors »

Browser wrote:
Grt2bOutdoors wrote:
Browser wrote:
The scenario where there is a rapid spike in rates and equities flounder or fall would be a big spike in inflation.
I don't see why this would be true. The causal order is usually the reverse: a spike in inflation followed by a rise in rates. I think Rick wrote about this a while back, pointing out that we could have a spike in rates without an accompanying spike in inflation and that TIPs carry this kind of risk. If Greenspan's thesis is correct and that ZIRP has artificially suppressed rates, it might make sense that rates could mean-revert without an uptick in inflation.
There is no inflation now, there will be no meaningful rise in inflation over the next 2-3 years. Why do I say that? We have falling commodity costs across the spectrum - metals, oils, agriculture that will translate into lower input costs, wages are being held down by slack demand and an oversupply of labor (never mind businesses are crowing about lack of skilled labor - that is just noise). At best, it will take 2-3 years to work through the oversupply on the commodity side, even then unless the consumer comes back in rip-roaring fashion demand for goods and services is not going to overshoot their supply. Higher interest rates will temper the demand for financial products such as home equity loans, consumer loans, credit cards, debt issuance for frivolous stock buybacks, etc. The Fed is going to be behind the curve if they don't start raising rates and soon.
It's good to finally meet someone with a working crystal ball. But as soon as the information gets out that there will be no inflation for the next few years everyone will be hanging onto their bonds and buying more. How will I make any money then? What I think is that it might be better to take the other side of that trade and get the heck out of bonds while you and everyone else are buying and holding. Then, if your crystal ball has lied to you, I'll be buying your bonds later at much lower prices and much higher interest coupons. :mrgreen: :D
Has any one calculated what I bonds may be offering come November? I think we'll be in for another 6 months of zero there.
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Grt2bOutdoors
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Re: Greenspan: we've got a bond bubble, Houston

Post by Grt2bOutdoors »

nukewerker wrote:So what happens when people rotate out of bonds? How do you know what the discount will be? Particularly if rates go up and you can put money in a savings account and not risk losing 16%.
Don't know, but you haven't lost if you don't sell and hold for duration. The loss comes when the institutional dumb money runs for the hills, only to find they were being chased by the boogie man instead of a real and present danger.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
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greg24
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Re: Greenspan: we've got a bond bubble, Houston

Post by greg24 »

We've been hearing bond warnings since 2008. At some point, I guess someone will be "right".

I guess I should shift from bonds to a different richly-valued asset, such as equities.

Or maybe I'll stay the course, focusing on the things I can control.
lowerleisureclass
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Re: Greenspan: we've got a bond bubble, Houston

Post by lowerleisureclass »

Nisiprius, let me say aloud what I have thought so very many times: thank you for being such a calming voice amidst the hysterical noise. I have saved several of your posts to refer back to, to keep me from going over the edge.
"At either end of the economic spectrum there lies a leisure class." -- Eric Beck, rock climber
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HomerJ
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Re: Greenspan: we've got a bond bubble, Houston

Post by HomerJ »

Browser wrote:It's good to finally meet someone with a working crystal ball.
You seem to think Greenspan has a working crystal ball... You've gotten completely out of bonds listening to people who you think are correctly predicting the future...

The truth is, bonds do not "crash" like stocks do... They are self-correcting... If rates go violently up to 5% from 2% (and it has to be violently for a bond "crash" to happen), then yes, we'll see a 15% drop in bond funds with average 5 year duration... But the yield will start going up, and all new bonds that bond fund buys will be returning 5%...

In the first year, that bond fund will probably only be down 12% or so... and in two years it will fully recover, and we'll all be very happy with our 5% yields going forward.

In other words, the "worst case scenario" for bonds... a sudden and fast rise in interest rates.... sounds really really good to me.

I'd love to be making 4%-5% on my bond funds in 2-3 years... and so would most retirees.
nukewerker
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Re: Greenspan: we've got a bond bubble, Houston

Post by nukewerker »

Grt2bOutdoors wrote:
nukewerker wrote:So what happens when people rotate out of bonds? How do you know what the discount will be? Particularly if rates go up and you can put money in a savings account and not risk losing 16%.
Don't know, but you haven't lost if you don't sell and hold for duration. The loss comes when the institutional dumb money runs for the hills, only to find they were being chased by the boogie man instead of a real and present danger.
Agreed. It was in fact a serious question with minimal amounts of my usually high sarcasm. In a way they are a lot like equities. If you don't sell, it will come back, just a matter of how long. Actually almost exactly like equities. I mean I don't exactly think all 500 s&p companies will go simultaneously bankrupt. Just like bonds won't go to zero. They can trade irrational for a while though. Either way probably just best to sit tight.
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steve roy
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Re: Greenspan: we've got a bond bubble, Houston

Post by steve roy »

Financial gurus -- and I think Mr. Greenspan's membership card in THAT club has long-since lapsed -- were placed on earth to make gypsy fortune tellers and Vegas magicians look good.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Rager1 »

Grt2bOutdoors wrote:
Browser wrote:
Grt2bOutdoors wrote:
Browser wrote:
The scenario where there is a rapid spike in rates and equities flounder or fall would be a big spike in inflation.
I don't see why this would be true. The causal order is usually the reverse: a spike in inflation followed by a rise in rates. I think Rick wrote about this a while back, pointing out that we could have a spike in rates without an accompanying spike in inflation and that TIPs carry this kind of risk. If Greenspan's thesis is correct and that ZIRP has artificially suppressed rates, it might make sense that rates could mean-revert without an uptick in inflation.
There is no inflation now, there will be no meaningful rise in inflation over the next 2-3 years. Why do I say that? We have falling commodity costs across the spectrum - metals, oils, agriculture that will translate into lower input costs, wages are being held down by slack demand and an oversupply of labor (never mind businesses are crowing about lack of skilled labor - that is just noise). At best, it will take 2-3 years to work through the oversupply on the commodity side, even then unless the consumer comes back in rip-roaring fashion demand for goods and services is not going to overshoot their supply. Higher interest rates will temper the demand for financial products such as home equity loans, consumer loans, credit cards, debt issuance for frivolous stock buybacks, etc. The Fed is going to be behind the curve if they don't start raising rates and soon.
It's good to finally meet someone with a working crystal ball. But as soon as the information gets out that there will be no inflation for the next few years everyone will be hanging onto their bonds and buying more. How will I make any money then? What I think is that it might be better to take the other side of that trade and get the heck out of bonds while you and everyone else are buying and holding. Then, if your crystal ball has lied to you, I'll be buying your bonds later at much lower prices and much higher interest coupons. :mrgreen: :D
Has any one calculated what I bonds may be offering come November? I think we'll be in for another 6 months of zero there.
If the inflation adjustment for I Bonds were based on the July, 2015 CPI-U Index announced today ((238.654/236.119)-1), it would be 1.07%. However, we'll have to wait until the September, 2015 CPI-U index is announced to find out. Note that I'm talking about the inflation adjustment, not the fixed rate.

Ed
Angst
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Re: Greenspan: we've got a bond bubble, Houston

Post by Angst »

lowerleisureclass wrote:Nisiprius, let me say aloud what I have thought so very many times: thank you for being such a calming voice amidst the hysterical noise. I have saved several of your posts to refer back to, to keep me from going over the edge.
Sometimes a picture really is worth a thousand words. Well, this pic does have words embedded in it... Nonetheless, this image which Nisi posted above says it all. He didn't even have to bother pointing out 2008 on the timeline.
rustymutt
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Re: Greenspan: we've got a bond bubble, Houston

Post by rustymutt »

longinvest wrote:Ha! ha! ha! ha!...! HA! HA! HA! HA! HA!
HAHHHHHHHHHH! Ha!
Bond Bubble! HA! HA! HA! HA! HA! HA!
HA! HA! HA! HA! HA!

BUBBLE! BOOOOOND BUBBLE! HA! HA! HA! HA! HA! HA!

OK, guys. A little mathematics lesson.

The current make up of Vanguard's Total Bond Market index ETF (BND) is as follows:

Maturity / Percent-of-assets
0-1 Year: 1%
1-3 Years: 26%
3-5 Years: 21%
5-10 Years: 35%
10-20 Years: 4%
20-30 Years: 12%
30+ Years: 1%

Let's assume that your worst fears come true: yields increase by 2% tomorrow all across the yield curve, even in the long end. That's really an end-of-the-world scenario.

Tell me! Tell me! What would happen to the NAV of BND?

Actually, it's easy to (grossly) estimate using simple mathematics: we just need to compute the cumulative losses for the bonds in BND.

We know that the approximate drop in price of a bond is equal to its duration for each 1% increase in yield. A gross estimate, for a 2% increase, is 2 times the duration. (The loss, for the second 1%, should be less than the original duration, but, hey, it's better to overestimate the loss than underestimate it).

0-1 Year: average duration = 0.5 year. Loss = (2 X 0.5)% X 1% = 0.1%
1-3 Years: average duration = 2 years. Loss = (2 X 2)% X 26% = 1.04%
3-5 Years: average duration = 4 years. Loss = (2 X 4)% X 21% = 1.68%
5-10 Years: average duration = 7.5 years. Loss = (2 X 7.5)% X 35% = 5.25%
10-20 Years: average duration = 15 years. Loss = (2 X 15)% X 4% = 1.2%
20-30 Years: average duration = 25 years. Loss = (2 X 25)% X 12% = 6%
30+ Years: average duration = 50 years. Loss = (2 X 50)% X 1% = 1%

Total = 16.27%

So, BND would immediately loose at most 16%, but, and that's the thing, all of its bonds would also immediately start yielding an additional 2%! Can you imagine! Yay!

There you go!


HA! HA! HA! HA! HA!
BOOOOOND BUBBLE! HA! HA! HA! HA! HA! HA!

Thanks for making my day! :happy :happy :happy :happy

Well said. I'm not stuffing my mattresses anytime soon.
Even educators need education. And some can be hard headed to the point of needing time out.
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Re: Greenspan: we've got a bond bubble, Houston

Post by denovo »

longinvest wrote: Total = 16.27%

So, BND would immediately loose at most 16%, but, and that's the thing, all of its bonds would also immediately start yielding an additional 2%! Can you imagine! Yay!
Devil's advocate, but right now the SEC yield on Vanguard Interm Bond is 2.57 percent. Say it goes up to 4 percent, your net return over 4 years would be 0. Or assume rates go up 4 percent, the loss would be about 32 percent, with a new 6.5 percent yield, make that 5 year 0 return.
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Re: Greenspan: we've got a bond bubble, Houston

Post by powermega »

JMO, but if you've made it this far into this thread, you should go back and re-read Nisi's post above.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Tigermoose »

I think we have all assumed that investors are rational and thus the rate rise would be managed and not dramatic. But what happens if an irrational run for the exits occurs in the bond market? How fast could rates rise if we have a panic sell? Again, this would not be rational, but an irrational reaction due to the 24/7 news media and fears of a lack of liquidity.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Grt2bOutdoors »

Tigermoose wrote:I think we have all assumed that investors are rational and thus the rate rise would be managed and not dramatic. But what happens if an irrational run for the exits occurs in the bond market? How fast could rates rise if we have a panic sell? Again, this would not be rational, but an irrational reaction due to the 24/7 news media and fears of a lack of liquidity.
It happened in 2009, it could happen again. Bonds were trading for 50 cents on the dollar, ole man Potter was paying cash, and folks who panicked and sold their shares for a pittance. Those who were buying then, made a killing.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Busting Myths »

Grt2bOutdoors wrote:
Tigermoose wrote:I think we have all assumed that investors are rational and thus the rate rise would be managed and not dramatic. But what happens if an irrational run for the exits occurs in the bond market? How fast could rates rise if we have a panic sell? Again, this would not be rational, but an irrational reaction due to the 24/7 news media and fears of a lack of liquidity.
It happened in 2009, it could happen again. Bonds were trading for 50 cents on the dollar,ole man Potter was paying cash, and folks who panicked and sold their shares for a pittance. Those who were buying then, made a killing.
You mean 1929...and that was a movie not a documentary.
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Re: Greenspan: we've got a bond bubble, Houston

Post by longinvest »

denovo wrote:
longinvest wrote: Total = 16.27%

So, BND would immediately loose at most 16%, but, and that's the thing, all of its bonds would also immediately start yielding an additional 2%! Can you imagine! Yay!
Devil's advocate, but right now the SEC yield on Vanguard Interm Bond is 2.57 percent. Say it goes up to 4 percent, your net return over 4 years would be 0. Or assume rates go up 4 percent, the loss would be about 32 percent, with a new 6.5 percent yield, make that 5 year 0 return.
I made it look worse than it is; BND's average duration is actually 5.7 years, so a 2% increase across the yield curve would cause a loss of less than 11.4% (don't forget that the second 1% of loss applies to a bond fund with a smaller duration). So, let's round that down to an immediate loss of 11%.

Now, let's use YTM as a 1-year return (it's reasonable for 1 year, not for longer, assuming a fixed yield curve). With a 2% increase, this means that BND would return 2.3% + 2% = 4.3% in the year following the drop, assuming yields remain unchanged and no bond is sold or reinvested. So, a 11% loss + a 4.3% gain leaves us with a 1-year loss of 6.7% if yields went up 2% all across the yield curve.

Note that BND would then use the capital of matured and sold bonds to reinvest in new long-term bonds, yielding much more than 4.3% (assuming the entire yield curve is still fixed 2% higher than now). Make that easily 5% or 6%? More? I'm not a yield curve specialist, but I doubt that 30-year bonds are currently yielding less than 3%, specially corporate bonds. DO NOT CONFUSE YTM OR SEC YIELD WITH FUTURE RETURNS!

I'm not afraid of the "bond bubble". :)
Last edited by longinvest on Wed Aug 19, 2015 4:21 pm, edited 2 times in total.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Fallible »

Did Greenspan actually say, in a direct quote, that "we've got a bond bubble."? I didn't see it or hear it', but wasn't able to hear all of the Bloomberg interview. Not saying he doesn't think there is or might be one, or that one is or might be forming, but just questioning whether he said there IS a bond bubble.
Last edited by Fallible on Wed Aug 19, 2015 5:10 pm, edited 1 time in total.
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Re: Greenspan: we've got a bond bubble, Houston

Post by ctreada »

At some point, you have to look at the yield you are getting vs. the potential downside... and you have to say "how many years would it take for me to break even?"

As yield approaches zero, the number of years to break even increases. Ergo, at some point, bonds become a guaranteed loss for say an 8 year holding period if rates rise. i.e. you're better putting your bond allocation at Ally Bank. I'm down to 10% bonds and the remainder of the allocation in cash savings. I sleep well at night about that, and I'm ok missing out on the ~1% difference in annual yield considering the risk.

Now all this could be BS, and we could enjoy negative yields in the US for a time like they saw in Europe earlier this year.

But the risk/reward er... stability tradeoff for me just simply isn't worth it when there are other stable options that wouldn't eat my principal.
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Re: Greenspan: we've got a bond bubble, Houston

Post by HomerJ »

Between 2004 and 2006, the Fed raised interest rates 17 times, increasing them from 1% to 5.25%

Would you like to see what damage this did to $10,000 invested in the Total Bond Market Index fund during this time?

It grew to $11,159 by the end of 2006.

There was a "crash" to $9,856 early on during this period of drastically rising rates.... Is that what people are worried about?

Image
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Re: Greenspan: we've got a bond bubble, Houston

Post by ctreada »

There's a huge difference between going from 0% to 1% and 4.25-5.25%

Where the risk free rate is absolutely affects the "stability" of the principal.

0-1% is an infinite increase.
4.25-5.25 is a 25% increase in the rate.

My point is simply about the risk/reward. The potential principal loss outweighs the risk at a certain point.
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Re: Greenspan: we've got a bond bubble, Houston

Post by longinvest »

ctreada wrote:There's a huge difference between going from 0% to 1% and 4.25-5.25%

Where the risk free rate is absolutely affects the "stability" of the principal.

0-1% is an infinite increase.
4.25-5.25 is a 25% increase in the rate.

My point is simply about the risk/reward. The potential principal loss outweighs the risk at a certain point.
Ctreada,

You seem to be ignoring that a Total Bond Market index fund is not a single bond with a decreasing duration; it is composed of a huge collection of bonds all across the yield curve (above one year). As I've shown above, you would need an end-of-the-world scenario to cause an annual loss of less than 7%. At that point (and before), the reinvested capital of maturing bonds would be reinvested at much higher yields (the curve is steep and would still be if the increase happened across the curve), something like over 5% or 6%, and possibly more. This means that the loss would be erased within a relatively short term. Some luck when rebalancing with stocks could even improve the scenario.

Now, in real life, it is highly unlikely for yields to go up all across the yield curve, so losses would be smaller, if any.

Yields could go down, too. Beating the bond market is a difficult endeavor, much like beating the stock market. :wink:
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Re: Greenspan: we've got a bond bubble, Houston

Post by HomerJ »

ctreada wrote:There's a huge difference between going from 0% to 1% and 4.25-5.25%

Where the risk free rate is absolutely affects the "stability" of the principal.

0-1% is an infinite increase.
4.25-5.25 is a 25% increase in the rate.

My point is simply about the risk/reward. The potential principal loss outweighs the risk at a certain point.
I said 1% to 5.25% in 3 years. Not 4.25% to 5.25% This has happened in the past. The recent past.

4% rise in the Fed rate in 3 years... And Total Bond Market Index Fund didn't "crash".
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Re: Greenspan: we've got a bond bubble, Houston

Post by z3r0c00l »

Even though it seems impossible now, the real nightmare scenario would be high inflation and massive inflation adjusted losses over the course of a decade or more. That is the big weakness in bonds; the risk of falling behind inflation over the course of a whole investing career. This is also why iBonds are so valuable.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Grt2bOutdoors »

Busting Myths wrote:
Grt2bOutdoors wrote:
Tigermoose wrote:I think we have all assumed that investors are rational and thus the rate rise would be managed and not dramatic. But what happens if an irrational run for the exits occurs in the bond market? How fast could rates rise if we have a panic sell? Again, this would not be rational, but an irrational reaction due to the 24/7 news media and fears of a lack of liquidity.
It happened in 2009, it could happen again. Bonds were trading for 50 cents on the dollar,ole man Potter was paying cash, and folks who panicked and sold their shares for a pittance. Those who were buying then, made a killing.
You mean 1929...and that was a movie not a documentary.
No I mean 2009, however, I tried to interject the phrase "ole man Potter" referring to the movie It's a Wonderful Life where Lionel Barrymore plays the old curmudgeon Potter who controls the bank and tries to purchase assets at super distressed prices. In 2009, we saw the same type of thing, except "ole man Potter" were vulture funds and distressed debt operators picking up illiquid asset based bonds including CMBS for pennies on the dollar. That is when the markets literally seized up, bonds that had been trading at close to par suddenly were being offered 50 cents or less on the dollar if they could get a price, a number of issues had zero takers, zero offers, there were no prices, valuations were called into question (investors were beyond irrational, they were frozen like a deer in the headlights) and that is when the Fed stepped in with their ABS Liquidity and TARP program to unfreeze it. Alot of folks have no idea how close we came to going over the cliff into an abyss, it was that hairy or shall I say "scary". Otherwise, we'd all be singing a much different tune today.
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Re: Greenspan: we've got a bond bubble, Houston

Post by Northern Flicker »

US treasuries, TIPs, and GNMAs were not trading at 50 cents on the dollar in 2009.

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Re: Greenspan: we've got a bond bubble, Houston

Post by TradingPlaces »

I think the time to stop listening to Greenspan was 2006, maybe even sooner.

I think Greenspan, of all people, has a lot to be blamed for the housing bubble and a lot of failed policies from that era: 2000 to mid-200xs
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Re: Greenspan: we've got a bond bubble, Houston

Post by Kevin M »

HomerJ wrote:Between 2004 and 2006, the Fed raised interest rates 17 times, increasing them from 1% to 5.25%
There's a big difference between the federal funds rate and bond yields of various maturities. Here's a chart of FFR, 5yr, 10yr and 20yr Treasury yields for this period:

Image

The 10yr rate increased a smidge, and the 20yr rate actually fell; i.e., the yield curve went from fairly steep to fairly flat, and actually inverted if comparing 20yr to FFR. So higher prices from falling longer-term rates can somewhat offset rising shorter-term rates. Also, higher yields then more quickly made up for price declines than they would starting from today's rates.

We'd also have to look at changes in spreads between corporate and Treasury bonds, because of the corporate holdings in Total Bond (which I believe were a greater percentage of the fund back then).

The main point is that the FFR is not the whole story when it comes to bond prices/yields.

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Re: Greenspan: we've got a bond bubble, Houston

Post by grog »

The price escalations of internet stocks in the late 90s and housing in the mid 00s were extraordinary and, in retrospect, obviously not justified by the fundamentals. But I do not see how bond prices have or really could experience a similar price escalation, particularly with the zero lower bound for interest rates. And as Japan has demonstrated, it's possible to have very low yields for decades, so neither is there an inevitable correction here as with a proper asset bubble.
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Re: Greenspan: we've got a bond bubble, Houston

Post by nedsaid »

So do we have "irrational exuberance" in the bond market?
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Re: Greenspan: we've got a bond bubble, Houston

Post by Kevin M »

nedsaid wrote:So do we have "irrational exuberance" in the bond market?
Could be, and could be that Greenspan is four years early again.

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Re: Greenspan: we've got a bond bubble, Houston

Post by nedsaid »

Kevin M wrote:
nedsaid wrote:So do we have "irrational exuberance" in the bond market?
Could be, and could be that Greenspan is four years early again.

Kevin
Wow. I was thinking that too. Great minds think alike!!
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Re: Greenspan: we've got a bond bubble, Houston

Post by gd »

Given their track records, I'm not clear why anyone would pick Greenspan's view of the world over Krugman's. PK certainly doesn't commit investment forecasting, but I don't think he's expecting a surge in interest rates any time soon. See his blog for reasons.
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Re: Greenspan: we've got a bond bubble, Houston

Post by longinvest »

Kevin, Nedsaid,

That's why I provided detailed calculations above. First, I provided a humorous and gross overestimate of immediate loss, then I provided a finer estimate of immediate loss and one-year loss. The selected scenario was an end-of-the-world one: a significant yield increase across the entire yield curve, where yields remain high for an entire year!

What did I find? I found that in the worst case, for a Total Bond Market index fund and a 2% yield increase across the curve, there would be an immediate loss of 11% and that within one year the loss would be reduced to 6.7%.

Yep! That's how a "bond bubble" bursts!!! BOOOOOOOONDDDDD BUBBBBBBLE! HA! HA! HA!

The thing is that we don't know the future. There are an infinite number of possible scenarios. Yields could go up only for certain maturities. Yields could also go down for other maturities or even for all maturities, leading to an immediate gain. We simply don't know!

If you wish, you can try to beat the bond market by concentrating all of your fixed income investments into a small subset of the market or CDs. But the fact remains that beating the bond market is no easier than beating the stock market.

Good luck!
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Re: Greenspan: we've got a bond bubble, Houston

Post by Tigermoose »

So I watched the Bloomberg interview with Greenspan.

He talks about time preference as being the foundation of where interest rates should be. Time preference is the human value of time. Interest rates should be a determination of the future value of money based on how much we value time.

"GREENSPAN: I would say you merely ask yourself what determines interest rates fundamentally. And it's human time preference. It's the extent to which we discount future values. You know one obvious case is take a look at people standing in line for a new Apple computer a year or so ago. Now what would they pay to get a position farther, closer to delivery date? That is human time preference. But human time preference is best measured by interest rates. Interest rates going all the way back in human history, as far back as we can get it, have not been significantly different from where we are in the pre-2008 period."


So I started thinking about this and looking into it. It seems to me that because our populations are aging and we have more income inequality, the time preference of capitalists has lowered. This is causing interest rates to go down. People with a low time preference are willing to save money and make interest at a lower rate, rather than feeling like they would rather spend the money now because saving at the given interest rate is not worth it.

So then I asked myself, what would cause the overall time preference to start increasing again?

1. Redistribution of capital to those with a higher time preference (younger and less wealthy)
2. The expectation that inflation will be higher than the given interest rate (but how does inflation begin picking up if the majority of capital are not spending but saving in bonds?)


#2 seems like the highly probable scenario that would trigger a reinforcing feedback loop that would continually drive up interest rates. I'm not sure what would trigger #2, however. Past QE and low interest rates have helped heal the balance sheets and restore the massive deflation that occurred in the financial crisis of 2008/9. But perhaps if governments continue these programs beyond a certain point the money supply will grow too large and #2 above will kick-in. How did that happen in the 1970s? Anyone see any similarities as to what was going on pre-inflation era 1970 and now?
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