Are Treasuries The Next Bubble?

Tulips a few hundred years ago, biotech stocks of the early 1990s, tech stocks of the late 1990s, housing in the early 2000s, commodities in 2008.  These were all bubbles that eventually burst.  But, what makes a bubble?  Is it just prices rising a lot?  No.  I think bubbles all have some similar characteristics:

  1. Prices rise dramatically
  2. Prices continue to rise longer than anyone thinks
  3. There’s a rational reason for the price rise
  4. Everyone explains why it’s different this time
  5. Greed takes over and the price move up accelerates
  6. Prices eventually come crashing down

So, does the recent rise in treasury prices have any of these characteristics?  I’d say it has all of them except for number 6 (at least for now). 

Remember the dot com boom in the late 1990s?  Everyone was saying that tech stocks could keep going up because technology was changing at such a rapid rate that the stocks justified huge multiples.  They were right about the technology.  Everything we thought the internet would be has come true.  But, the demand for the stocks eventually slowed down.  At the same time, the supply was increasing of those stocks.  That was a combination of a ton of IPOs and companies issuing a lot of stock in the form of options, etc.  How about housing?  Surely that would go up forever.  We had more people moving to the country than leaving and everybody would need a house.  And when you add in low interest rates, how could prices come down?  They did.  Commodities.  The world’s industrializing and the need for commodities won’t slow down.  It did.  Commodities just since July 1st have fallen 55%.  Now, I’m on record as saying that I think we’ll have another several year run for commodities.  But, it was still a bubble.  Which brings us to treasuries.

Everyone knows that the economy started to weaken and rates started coming down.  But, when the economy fell off a cliff in October, the panic we saw caused everyone to bail out of anything that wasn’t a treasury.  That caused rates to fall.  Then the government got involved.  They started buying a ton of treasuries to drive down rates even further which would in turn cause us to refinance and use our capital in a more productive way.  Since then, we’ve seen rates actually go negative on short-term treasuries.  But, it’s not just short-term treasuries, long-term rates are at multi-generational lows.  The ten-year treasury is around 2% today and looks as if it’s going to 0% at this rate.  You can see the picture below, which is the iShares Barclays 20+ Year Treasury Bond Fund ETF (TLT).  Just since November, the price of long-term treasuries has risen over 30%!  Bonds, 30% in 2 months?

TLT
I’ll agree that rates should be falling.  But, look at that picture above.  I don’t care what you’re trading.  Whenever you see a picture like this as a trader, you sell it.  Or at least, you don’t buy it.  Now, bubbles can last for a while.  Sometimes several years.  The Fed has already told us they are going to leave interest rates very low for a long time.  But, can they buy enough treasuries to to keep rates at 2% on 10-year treasuries forever?  I don’t think so.  I’ve been short treasuries and long other bonds for some time.  The short hasn’t worked yet but I’m real close to averaging down into my short.  The key is to continue to buy other types of bonds in addition.  It’s a pairs trade.  You can short treasuries a few ways.  You can physically go out and short treasuries.  You can buy an ETF that shorts treasuries or you can buy a mutual fund that shorts treasuries.  But, remember, this isn’t a trade.  It’s a longer term macro play.

Number 6 hans’t happened yet, but I’m betting it will.

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