The New Insanity: Chasing Bonds

Yesterday's bond rally was truly unprecedented, with yields collapsing to all-time lows of 3.47%. This flight-to-safety panic catapulted bond futures more than 7 full points into the aftermarket highs. This was one for the record books, and it likely signaled the culmination to this move. That's not to say that bonds can't work a little higher in the weeks ahead, but the big move is likely behind us -- any further upside will be accomplished grudgingly, if at all.

In very simple terms, it appears that many investors feel that their alternatives are shrinking daily. In a desperate move to lock in some kind of yield, anyone with cash in hand finds that the 1- and 3-year notes are yielding close to nothing, so he goes to the 10-year, which isn't offering much more. Finally he says, "Aw, heck" (or some equivalent) and buys the 30-year bond at all-time highs and accepts an all-time low yield of about 3.5%. Desperate times call for desperate measures, but these are just silly decisions by investors in panic mode.

Is this deflation, or just a return to the natural order of things?

Of course, all the talk about deflation (what happened to all the inflation worries of just a few weeks ago?) and concerns that the economy is headed for a complete standstill are fueling the current bond mania. Apparently, the thinking goes that prices are falling, so we must be headed into a long-term death spiral of deflation as in the 1930s. Yet isn't this what happens every time a bubble bursts? Aren't prices, by definition, supposed to come back down to earth every so often? I mean, when housing prices were doubling every couple of years, I don't recall a flight out of the bond market as if inflation were headed to infinity.

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At the time of publication, Schiller was long equity mutual funds up to 50%-75% levels; short bonds up to 15% levels, although holdings can change at any time.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.