Bond Bubble About To Burst?

With the S&P 500 trading within a stone’s throw of all-time highs and Goldman Sachs recently drawing calculated comparisons between leading tech stocks today to those leading the dot-com bubble in 2000, investors are growing increasingly concerned that the stock market may once again be entering bubble territory. According to former Federal Reserve chairman Alan Greenspan, investors should be much more concerned about bond prices.

In a new interview, Greenspan said interest rates remain well below where they should be. He expects rates to experience a rapid rise at some point in the near future.

“We are experiencing a bubble, not in stock prices but in bond prices,” Greenspan said. “This is not discounted in the marketplace.”

Related Link: Yellen Puts A Crimp In Financial Rally

Differing Opinions

Many bond investors are predicting the secular decline in interest rates that has persisted for decades will continue in the long term, but Greenspan sees a potential inflection point when global central banks end their accommodative monetary policies.

A bursting bond bubble will also drag down the stock market, Greenspan said.

Fed Model

Greenspan is a subscriber to the Fed Model of economics, in which stock and bond values should be compared only to each other on a relative basis. The current gap between 10-year adjusted bond yields (0.47 percent) and the S&P 500’s earnings yield (4.7 percent) is 21 percent higher than its 20-year average.

In recent years, large upticks in bond yields haven’t triggered bond and stock market sell-offs. Ten-year Treasury yields spiked above 3 percent in 2013 and 2016 didn’t result in stock market weakness.

Greenspan says stock market resiliency will be put to the test as the U.S. Federal Reserve begins to unwind its $4.5 billion balance sheet and other central banks around the world dial back their economic stimulus plans.

So Far, So Good In 2017

So far this year, it has been business as usual for stocks and bond ETFs: 

• The SPDR S&P 500 ETF Trust SPY is up 10.6 percent.
• The iShares Barclays 20+ Yr Treas.Bond (ETF) TLT is up 4.3 percent.
• The iShares iBoxx $ High Yid Corp Bond (ETF) HYG is up 2.4 percent.
• The iShares IBoxx $ Invest Grade Corp Bd Fd LQD is up 3.3 percent.
• The iShares S&P Natnl AMT – Free Munpl Bd Fd MUB is up 2.3 percent.