Shiller’s Warning: Escape The Bond Bubble

Investors are struggling to find a new direction this year. So why not turn to the latest edition of an investment classic from Nobel Laureate Professor Robert Shiller of Yale University?

He is not the first person to warn that bonds are in a bubble and will certainly not be the last. But he comes with a flawless track record of spotting the dot-com crash and the subprime housing crisis as the last two major US investment bubbles.

US 30-year treasury yields have been as low as 0.5 per cent recently. That’s off the scale historically. Yields are in an inverse relationship to bond prices, so that makes bonds their most expensive in history.

Treasury bonds are supposed to be the safest of all assets. But southern confederate bonds did default in the US civil war, and international markets are full of examples of bond failures. Think Russia in 1998.

In the third edition of his bestseller Irrational Exuberance, published last month, Shiller sees the bond market as a far from a safe bet as many long- term bond yields around the world “are fast approaching zero on an expected inflation-adjusted and even nominal basis”.

He told one interviewer last month: “We can’t go below zero yields, not far below zero…I think it’s a risky time to be investing in long-term fixed income.”

The question then is when will bonds crash? Bond market king Bill Gross was fired last year for calling the end of this market too early. Shiller has not survived this long in the forecasting business without being able to hedge his bets.

“Yields have been trending down since 1981, over 30 years now…There could be a major turning point again in coming years, but I see no reason to think that such is imminent.”

So that’s a warning followed by a cop-out. He’s a professor after all, not an investor. However, the 10-year US Treasury bond is the benchmark against which all global investments are measured. If that is in question then how can investors measure performance?

Most likely by a return to a much earlier form of money, which the central banks cannot print. And let’s face it – central bank action is what has destroyed bond yields through quantitative easing (QE). Far from causing inflation, QE has left us in a deflationary debt trap.

Investors in long-term bonds have been robbed to enable governments and companies to carry their immense debt burdens. In the coming crash, they will discover that these debts are now worth nothing.

What will still have value when paper money is worthless? The value of gold and silver will shoot up to cover the balance in an international currency reset. For the world can live without debts but not money as a medium for trade.

It is hard to imagine just how this will pan out in practice. But then the subprime crisis and the near nemesis of 2009 were not expected or at least not in the form that it happened.

Clearly, there will be some very big losers, among them pension funds and financial institutions with huge bond holdings. The winners will be those with gold, silver and associated assets.

In the reset, the bubble would be in precious metals and subsequently a new monetary system would gradually leverage up again depressing the price of these metals, although that process could take many years, just like the winding up of the current monetary system.

What would this mean for stock markets? The idea of smooth rotation by investors out of bonds and into equities is a non-starter. The disruption a bond market crash would cause to the global financial system would be an earthquake under equity valuations.

Besides stocks are also in a bubble. The Dow Jones and DAX hit new all-time highs last month. Shiller is famous for his cyclically adjusted price-earnings ratio that compares current prices to the prior 10 years’ worth of earnings.

His new book notes that this is “higher than ever before except for the times around 1929, 2000, and 2008, all major market peaks.”

If interest rates go up – as they would very sharply in a bond market crash – then that would also be awful for real estate. Investors really have nowhere else to hide except for precious metals in a bond crash.