Monday, April 27, 2015

Global Government Bonds Have Become Tulip Bulbs

The bubble and burst we experienced in 2000 was due to overly accommodative monetary policy that led to speculation concentrated in U.S. technology stocks. The response to that crash was an even more accomodative monetary policy that led to a bubble in U.S. real estate, which then spilled over into other real estate markets around the world (Spain, Portugal, etc.). 

When the real estate bubble burst we received a much larger dose of heroin, which has been pumped into the financial markets since 2009. This has not only come from the United States, but from other major central banks around the world (Japan and Europe). As I write, there are rumors that China is preparing to join the QE party. 

This time around the heroin injections are so large they essentially created a bubble in everything. The bubbles in the financial markets today are so pervasive that if you look around they difficult are to spot because almost every major asset class is trading at obscene price levels together. 

However, even in today's "everything bubble" there is an asset class that stands out above the rest; bonds. The insatiable appetite for bonds today has been pushed so far to the extreme that comparisons to tulip bulbs in the 1600's and technology stocks in 2000 may be the only appropriate comparisons. 

Take a look at the chart below which is a European government bond matrix put together by Pension Partners. It provides a snapshot of the yields you will receive as an investor for purchasing a government bond at a specific duration (number of years). The areas shaded red show negative yields, meaning you are willing to pay that government every year to hold your money. 



When you reach the peak of an asset mania it is easy to see that investors are purchasing the asset to "flip" it to the next buyer, not hold it for a long term investment. No one can rationally come up with an argument as to why they would pay the German government to hold their money for 9 years. An investor making this purchase today is hoping to flip the bond to the next buyer at a yield more negative than it stands today. 

The ECB has already announced they will begin purchasing bonds with negative yields, which should only further drive this mania further off the cliff of reality. How low can yields go? I have no idea. To guess would be like putting a final price on Pets.com in 1999 before it reached its zenith and began to free fall. At least at the peak of the tulip bulb mania buyers were not paying sellers a monthly fee to own the tulips. 


53% of all global government bonds currently trade below 1%. $5.3 trillion in government bonds currently trade at a negative yield. Many of these governments have no possible way of ever repaying the money they are borrowing. Their only hope moving forward is to continue to roll the debt and hope there is always a steady buyer there to finance their needs. Back in the days of subprime mortgages there was at least a chance the borrower could or would repay the debt on the mortgage. 

When yields finally bottom and reverse course the widespread destruction in the financial markets will be so pervasive that no asset will be safe in the wake. Both real estate and stocks are dependent on today's low borrowing costs to push their markets further into the stratosphere. 

Many commodities today are sitting at or close to their 2009 lows. Cash is the most hated asset on the planet. I continue to accumulate both (with a much heavier emphasis on cash). 

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