The past 10 years have brought us 3 major bubbles; tech in the late 90’s, housing through the early part of the decade and most recently the run-up in commodities.  One common theme amongst these bubbles (and the likely creator) was the massive cattle like herds of investors running to get into the hottest new thing; whether it was pets.com or it was that overpriced $700,000 house in California that a guy with no job was able to buy with easy credit.

Treasuries have now managed to exhibit similar qualities to these previous bubbles, with investors running to so called quality. Demand has superseded rationale, with investors paying high premiums for so called riskless assets that are yielding next to nothing.

Yes, the stock market has taken away a great deal of wealth, but where is the quality in a government bond that is yielding next to zero short term and less than 3% long term. The idea that investors will continue to buy this paper that is yielding next to nothing seems crazy; particularly when the threat of inflation, largely driven by government spending, is not only possible but likely.

Short term rates will likely remain subdued over the next year (Keep in mind these rates are largely influenced the Fed). The flipside of this is that longer term rates are more market driven and any increase in prices (i.e. inflation) will likely send treasury prices reeling as yields increase to keep pace. Clearly long term rates can remain lower in the near term, as the “safe haven” trade continues, but can it last long term?

A few scenarios can play out here:

1.    The market recovers and money flees treasuries to capture any uptick in equities. (not likely near term)

2.    The Fed continues to print money to spur economic recovery and inflation ensues. (possible)

3.    The Fed buys long term notes and bonds to keep prices elevated and rates artificially low (trying to control inflation), likely spurring inflation as the U.S. dollar loses value. (possible)

This puts investors in a precarious spot. The equity markets are horrendous with little sign of improvement over the next year and if we are correct regarding the treasury market, short term rates will continue to yield nothing and be overpriced and long term prices will likely trend downward, bursting a “fear fueled” bubble. The biggest question is; how long will investors hang on to this trade knowing that they are overpaying for these government securities? If you were to look at the flow of treasuries to China and Japan, you will see that some investors are beginning to see the light. In this case the light they are seeing is most likely the train coming at them and not the end of the tunnel.

A famous investor from Omaha recently said, "Beware the investment activity that produces applause; the great moves are usually greeted by yawns." When is the last time you applauded farmland?

-GDH