Saturday, December 27, 2008

Best Year for Bonds

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You wouldn't expect an article like this ("Bonds set for best year in over a decade") to come as good news for someone who's short Treasury bonds. However, I am thrilled with this article.

Every financial bubble we've seen in the past decade has been formed by a good idea taken too far. The dot.com boom and bust started out with a good idea , commerce online with lower barriers to entry, that got taken too far. In 2004 and 2005, asset allocation towards real estate, always a "safe" bet, was a good idea that got taken too far. This past summer, buying oil futures in the face of unrelenting demand and tight supplies was a good idea... that got taken too far.

Every time you see too many people piling into a good idea, chances are, it's going to get taken too far. The Treasury bond market will be no exception. The allocation of capital away from stocks and into bonds is a good idea, at the beginning of a panic. However, once everyone has piled into bonds, they no longer represent a safe haven. When bonds were yielding 4+% at the beginning of this past autumn's collapse in equity prices, the "flight-to-quality" made some financial sense.

Buying 30-Year Treasury bonds yielding 2 1/2% is not a "flight-to-quality"; it's a flight to stupidity.
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