Is The Bond Bubble About to Burst?

Remember the Dot-com bubble?

As investors decided, maybe earnings really do matter. The Nasdaq lost nearly 80% of its value in the two-year market sell-off that ended in 2002.

Then there was the housing market crash which destroyed one-third of U.S. home values, more in some markets.

Now, some believe we are on the cusp of a bond bubble.

In the aftermath of the fall of Lehman and unwinding of the housing bubble, investors began turning to bonds, especially Treasuries, as a safe haven.

Now, many believe too many of us have parked our savings there and the consequences could be dire if rates were to spike unexpectedly.

Don't get me wrong, a strong durable goods order report sparked sales of Treasuries last week.

Yields moved higher, but not to stratospheric levels. The 10-year Treasury yields rose just over 2% before falling today just below that level.

But it's worth considering: what would happen if the Federal Reserve took away the punch bowl and allowed rates to rise?

Today, The Wall Street Journal says bond prices are more volatile than usual because of a quirk of bond math: because rates are so low, prices are even more sensitive to yields, or in bond jargon, has increased their duration.

In other words, low yields means more of the value of the bond is in the lump sum received when they mature, and that makes prices more volatile.

Here's the math of it, according to The Journal: if current 10-year Treasury yields rose to more normal levels, say 4%, prices would fall from 97.25 to 81, a 17% hit.  That's a big fall for someone who believes they are invested in a super safe investment.

Of course investors can hold their bond until maturity, but who wants to stick with an investment yielding less than 2% for a decade if returns elsewhere are rising?

You get the picture. If, and when the economy stages a sustained recovery, the bond market could bite those over-invested in the asset class.

Remember, in the past two years alone, investors put more than $1 trillion into global mutual and exchange-traded bond funds.

It’s beginning to feel a little like 2002 all over again.