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Thursday, August 19, 2010

Bond Bubble Blasphemy

Look... I'm not going to make the claim that Treasuries are (or are not) in a bubble, but when I see such disingenuous reasoning in a major newspaper, I cannot let it go. Jeremy Siegel and Jeremy Schwartz with some faulty rational via the WSJ:

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.

Shorter-term Treasury bonds are yielding even less. The interest rate on standard noninflation-adjusted Treasury bonds due in four years has fallen to 1%, or 100 times its payout.
Uh... no. Bonds have two components, interest AND principal. Bonds are not selling at 100x their payout (they are paying less than 1x their total payout including interest and principal). They are trading 100x their interest.

And that is the key to the whole argument. Is the yield too low? Quite possibly, but with a bond you KNOW (assuming they have no credit risk) what you will get back in nominal terms (the question is how much in real terms). That is the key difference between bonds trading at 100x interest and stocks trading at 100x their earnings. In the case of stocks you have no guarantee as to what earnings or stock price appreciation you will get.