Emails of the day (1-3)
Comment of the Day

November 28 2012

Commentary by David Fuller

Emails of the day (1-3)

On the bond market bubble (note - there have been others on this subject but the questions are quite similar):
"I enjoy your service always, but I thought your comment of the day and the audio of Friday was exceptionally good thanks very much. I wish i had followed them as closely as i do now after my semi retirement. I am very interested in your comments of the "bond bubble"; and I wonder whether or not you are considering to short it; and even if you don't would you kindly advise your subscribers when you feel is a good time to start shorting it. Thanks again for the excellent service to both of you."


"Thank you for your warning on the 'bond bubble'.

"I am interested in your thoughts on how the 'inflation linked bonds' (both gilts/TIPS) would react, when the bond bubble collapses?"


"Firstly I'm very pleased that you are back in harness at FM.

"In your audio of 21/11 you again reminded subscribers of the risks involved in holding Treasuries pumped up on the adrenaline of QE. I have two questions for you.

"In your opinion will linkers be equally hit by rising yields taking into account that rising bond yields may have an upward influence on inflation?"

"Moving on to corporate bonds - these are by and large backed by positive balance sheets particularly when we are looking at the bonds of your much revered 'Autonomies'. Now although such balance sheets will offer protection against rising yields I would have to consider that quality corporate bonds and creditor nations Sovereign debt will still experience contagion from rising yields/falling prices of debtor Sovereign bonds?

"I appreciate that the strategy would be to favour many of the equity themes advocated by FM over the past year or more but in an increasingly regulated advice world we see regulators such as the FSA here in the UK becoming more and more fixated upon the need for 'appropriate' risk related investment base upon the premise that equities are considered to be higher risk whereas bonds are deemed as lower risk rated.

"The stance of the regulators could deter many financial advisers from offering advice that will effectively reduce their clients risk

David Fuller's view Many thanks for these interesting and challenging questions.

We cannot know precisely how the bursting of the bond market bubble will play out, for two reasons: 1) although over 30 years in duration and counting, the last few of these have been fed by unprecedented amounts of quantitative easing (QE); 2) investors' responses and actions will not always be rational.

Central banks will be more concerned than most to avoid a disorderly end to the bond market bubble which they have certainly helped to create. I wish them every success in this effort - I mean this sincerely - because they will need both genius and luck.

As for the second point above, a bursting bubble causes both the fear and reality of collateral damage. For instance, frightened people who are losing profits in bonds are likely to sell some other assets, either to meet margin calls or because they fear that gains in those markets may be vulnerable as well.

This will not always be certain, logical or rational. Therefore, expect some extreme volatility in other instruments. However, markets where people have the biggest profits are likely to be most vulnerable.

Yes, I would expect inflation-linked bonds and both gilts and TIPS to react. The unknowable will be the speed of descent, which central banks will attempt to moderate.

As for shorting bonds, yes, I hope to and both Eoin and I will certainly be commenting on these markets. However, shorting within the early stages of a bursting bubble is certainly stressful and not easy. Therefore, options, particularly out-of-the-money, are worth considering.

Remember, bubbles are very profitable for those who are long but also extremely dangerous when they burst. If we short too soon, big losses occur, and I can say this with personal experience. Volatility in the end-game can be terrifying. In other words, it will be easier to identify the bursting bubble than to profit from it.

Corporate bonds are less of a bubble, albeit still inflating, but I think they would certainly be affected, possibly with a time lag if central banks can prevent chaos. It would be prudent, in my opinion, to be aware of the risk of widespread contagion.

Thanks for the comments on "an increasingly regulated advice world", in the last email above, and yes, I am worried that this has contributed to the distortion of these markets and your concluding question is certainly relevant.

My guess is that the bond bubble will continue for a while, not least because the Fed is now talking about rates staying on hold until 2015! How do they know? Or more importantly, what if they change their mind? A clearly improving US and global economy may be the best warning.

Lastly, if these comments are viewed as an emotional overreaction in a few years' time, I will laugh at myself with considerable relief. Meanwhile, please be aware of the growing risk that the bond market bubble bursts within the next few years, subject to central bank actions, and be disciplined in your financial transactions.

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