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Bond Short Plays

By Roberto Pedone

BALTIMORE ( Stockpickr) -- Is the U.S. bond market trading at bubble levels, ready to bust at any moment?

That's a conclusion that can be easily reached when you consider the amount of money flowing into this sector from the retail investor. The Investment Company Institute, which tracks money flows into retail mutual funds, estimates that individual investors took out $9 billion from U.S. stock funds in the first three weeks of July, and poured $20 billion more into corporate and government bond funds.

Clearly, the retail crowd is looking for a safe place to park their money since the stock market has produced very little in terms of total returns this year. What's strange about this overwhelming money flow into bonds is that the returns in the fixed income market are currently low, but investors are still willing to take those low returns in exchange for the promise of the return of their money.

This could mean that market players are worried that a potential collapse is coming for the stock market, and that the economy is heading for a double-dip recession.

It could also mean that investors believe that the Federal Reserve will continue to keep rates low to fight off any chance of rising inflation. Rising rates or high inflation would do considerable damage to the fixed income market. But let's face it: Interest rates will not be this low forever, so some of the arguments made by the bond bulls are starting to look misguided.

Retail investors aren't the only market players who're giving up on stocks and the market in general. Legendary hedge fund manager Stanley Drukenmiller said Wednesday he is retiring from the money management business. Drukenmiller, who is famous for his bet against the British pound before Black Wednesday in the 1990s, said the stress of managing an enormous fund and competing in the markets has become too much.

With Drukenmiller and the retail investor largely throwing in the towel on stocks, market players might be best served by putting on their contrarian thinking caps. A crowd mentality in any type of investment is usually a guaranteed receipt for disaster, and that seems to be what is developing in the bond market.

The one argument against a bond bubble is that bonds have never seen a major collapse in price. In fact, the worst 12-month loss for the U.S. bond market was less than 10%. However, the same things were said about the real estate market right before that bubble popped. The point is that when the least amount of people expect something to happen in the market that is preciously when the possibility of it happening increases dramatically.
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