Which are riskier: stocks or bonds? Independent Financial Advice
Posted by Don Martin on Wed, Apr 04, 2012 @ 05:16 PM
Bond bubble myth explored
|
Bond prices are very high relative to their prices over the past 40 years so it is tempting think they are in a bubble and will drop sharply in price. However in the past century about a third of the time Treasury bonds have been yielding under 3%, so today’s 10 year bond yield of 2.24% is reasonable since the unemployment rate is very high (especially when considering the U-6 measure of hidden unemployed people). U.S. Treasuries are used by foreign Central Banks as a risk free asset in lieu of owning gold. When the supply of Treasuries is decreased it actually hurts Emerging Market economies by causing a global liquidity shortage. Institutional investors are too big to use an insured bank CD so they use Treasuries as a form of cash bank deposits. When there is a shortage of this cash equivalent then foreign Central Banks encounter problems fulfilling their mission and this can lead them to tighten their own economies, leading a crash in the Emerging Markets. (The long term and intermediate term Treasuries are not cash equivalents because there is risk that prices could go down if interest rates went up.)
The “TLT” ETF that holds long term Treasuries is now at $112; it was at a multiyear low of $82 in March, 2010, it was as high as 122 in December, 2011. This implies the downside risk would be 27% drop in value. Compare that to the SP500 that dropped 52% from the five year peak in 2007 to the low of March, 2009. The stock market dropped almost twice as much as the bond market and bond owners until recently got a much larger yield than stockholders, so the total return was far better for bonds than for stocks.
Investors should seek independent financial advice.