Low Yields Don't Make a Bond Bubble

NEW YORK (TheStreet) -- When did Wall Street economists and strategists start warning investors about a pending bond bubble due to the extremely low yield of the U.S. Treasury 10-Year note?

To answer this question, I dug deep into the archives of my stories for RealMoney.com. Back on June 14, 2005, I wrote "No Bond Bubble, but Utilities May Puff Up." In the very first sentence of my story I stated: "Contrary to what some pundits claim, there can't be a bond bubble in the markets now."

Here we are seven plus years later, and I continue to say essentially the same thing about U.S. Treasury yields. You cannot have a bond bubble because of low yields, but you can have a "yield bubble." The U.S. Treasury 10-Year yield rose to bubble territory between 1981 and 1986, as shown in the chart below courtesy of dshort.com.

The chart shows that, when Paul Volcker was Federal Reserve Chairman, the Federal Open Market Committee raised the federal funds rate to 20.06% in January 1981. This was followed by a peak in the U.S. Treasury 10-Year yield at 15.68%, which to me defined the top of the "yield bubble" for that note. As the chart clearly shows, the 10-Year yield has been declining ever since and reached a record low of 1.439% on June 1.

If you bought the 10-Year U.S. Treasury on June 10, 2005, your yield to maturity would have been about 4%. Today, this security would now have three years to maturity. Compare this to the yield on the current 3-Year U.S. Treasury note, which closed Tuesday at 0.326%. This trade had a much better return than buying the S&P 500 back on June 10, 2005.

To prove my point, let's compare a trade in the iShares Barclays 20+ Year Treasury Bond Fund ( TLT) to a trade in the SPDR S&P 500 ETF Trust ( SPY) looking at the weekly charts for both below.


Courtesy of Thomson/Reuters

If you purchased TLT on June 17, 2005 at $93.50 and sold at $130.50 on Monday, July 16, 2012, you made a 37-point profit for a gain of 39.6%. For a U.S. Treasury 10-Year, you would have also made 4% in each year since June 2005.

Compare this to buying the SPDR S&P 500 ETF at $120 on June 17, 2005 and selling it at $135 on Monday, July 16, 2012, which would make you a 15-point profit for a gain of 12.5%. Thus the bond ETF outperformed the S&P 500 by 27.1% over the past seven plus years. This occurred while many analysts and strategists told investors to avoid U.S. Treasuries as dead money.


Courtesy of Thomson/Reuters

I am not saying that this trade will work today. The yield on the 10-Year U.S. Treasury is trading around 1.50% and my semiannual risky level is at 1.389%. Instead, I recommend booking profits on U.S. Treasuries and shifting to cash as your safety strategy.

In my opinion investors are currently flocking into the U.S. 10-Year note at 1.50% because they are worried that U.S. stocks could crumble as they did between October 2007 and March 2009. The S&P 500 declined by more than 50% to a March 9, 2009 low.

Keep in mind that Federal Reserve policy is encouraging a lower 10-Year yield and that the Fed may cause the U.S. economy to turn Japanese. On Tuesday, the Japanese 10-Year yield closed at 0.77%.

At the time of publication, the author had no positions in any of the investments mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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