August 31, 2010
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Shakespeare begins “The Tragedy of Macbeth” with three witches imparting their prophecies to Macbeth, the would-be king. But prophecies, Macbeth learns to his chagrin, do not always turn out as expected.
The latest economic prophecy, which has gripped investors’ fears for the past three years and counting, is that a ‘bubble’ in US Treasury bonds is about to burst. Hyperinflation is just around the corner, the prediction goes, and US Treasury bonds, driven up in price to record levels by unprecedented policy measures, are about to crash. Here are but a few of the dire warnings that are circulating the subject. It is not my intent to label these ‘seers’ of the future as false prophets, but they have staked their claims to positions as forecasters, and I will treat their comments accordingly.
"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."
Warren Buffett
“Ten years ago we experienced the biggest bubble in U.S. stock market history – the Internet and technology mania that saw high-flying tech stocks selling at an excess of 100 times earnings. The aftermath was predictable: Most of these highfliers declined 80% or more, and the NASDAQ today sells at less than half the peak it reached a decade ago…
A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds… The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout…
The possibility of substantial capital losses on bonds looms large. If over the next year 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4%, as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?”
Jeremy Siegel and Jeremy Schwartz
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