Global Bond Bulls: Shaken or Stirred?

Mark Hulbert observes that the U.S. must pay a higher interest rate on its 10-year bond than does Greece, by 0.6 of a percentage point, believe it or not.
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The U.S. government must pay more in interest for its 10-year bond than the Greek government must for theirs. The 10-year U.S. Treasury is currently yielding 1.59%, versus 0.96% for the Greek 10-year.

How can that make sense?

It’s not as though the Greek economy is in better shape than the U.S. economy. Though it’s not the basket case it was a decade ago (when it almost brought down the Eurozone), it hardly is the picture of health, either. Unemployment is running around 18%, for example, and projected by the International Monetary Fund to remain in double digits for the foreseeable future.

And Greece is hardly alone in getting lower rates for government borrowing. Remember the PIIGS -- Portugal, Italy, Ireland, Greece, and Spain -- which were given this unflattering acronym because they were the weakest economies in the Eurozone? Each of the four PIIGS, beside Greece, also has a lower 10-year government bond yield than the U.S., as you can see from the accompanying chart.

Hulbert Chart 021820

This situation is a classic illustration of what’s known as the Greater Fool Theory in investing: You buy something that you know is overvalued, in the belief that you can find someone even more foolish to whom you can sell it later at an even higher price.

There can be no doubt that the Greek 10-year bond is overvalued, of course. The IMF is projecting that Greek inflation will average around 1.43% annualized in coming years, and on that assumption those buying the Greek 10-year bond at current yields are locking in an annualized loss in inflation-adjusted terms of 0.47%.

This isn’t to say that short-term traders will necessarily lose money over the near term if they buy the Greek bond. But it’s important to distinguish between them and longer-term investors. And traders sometimes earn spectacular returns investing in overvalued securities, so long as they are not the last fool.

I’m reminded of how one adviser put it to me years ago: The next-to-last person who bought tulip bulbs during the 17 century’s tulip mania thought he was a genius.

A hallmark of the Greater Fool Theory is when the only reason a security’s price rises today is because it did yesterday. That’s because in a market that doesn’t trade on fundamentals, yesterday’s returns are all that anyone has to go on. This momentum trading initially looks too good to be true, as fabulous short-term returns draw in “greater and greater fools,” propelling prices ever higher and seducing yet more fools.

Eventually, however, the party comes to an end. And when it does, there will be no fundamentals providing a safety net under plunging prices.

The bottom line? Traders buying the Greek 10-year bond at current yields may very well turn a short-term profit. But there is no doubt how this story will end.

Robert Rhea, the famous market technician from a century ago, wrote that “there are three principal phases of a bull market: the first is represented by reviving confidence in the future of business; the second is the response of stock prices to the known improvement in corporate earnings, and the third is the period when speculation is rampant -- a period when stocks are advanced on hopes and expectations.”

Though Rhea was writing about stocks, his comments could just as easily be applied to the global bond market today: We are in the third and final phase of the bond bull market. Watch out below.