Hear that popping sound? Some fear a bond bubble will burst

The dot com bubble and crash. The real estate bubble and crash. Investors involved in those markets over the past 15 years are well aware of the opportunities and risks associated with rapid appreciation followed by an equally steep decline, whether it’s tech stocks or residential property. So a wise investor might look ahead to the next potential bubble that’s about to burst — and avoid the loud “pop” that’s set to sound.

Enter the bond market. Some financial analysts expect the bond market to crash in 2011, although others aren’t as concerned.
“The ‘herd mentality’ has billions of dollars pouring into bonds, and particularly treasury bonds,” writes

Ken Faulkenberry in a story on the Arbor Investment Planner website.
Faulkenberry says conservative investors can be attracted to treasury bonds because they’re supposed to offer the ultimate safe investment. “Many investors believe they are accepting a low return in exchange for safety, but actually they are accepting a low return and high risk.”

Faulkenberry, who earned a master’s of business administration degree from the University of Southern California and airs a weekly financial radio program in Houston, says he’s worked as an investment planner for 20 years.

“The Federal Reserve, in an attempt to avoid deflation and stimulate the economy, is artificially holding down interest rates,” he says. “This is creating another bubble, this time in bonds. … This is an example of the middle class being duped into funding bad policies.”

Some local analysts don’t foresee such a dramatic crash in the bond market. “I don’t think it will be a bubble bursting,” says Doug May, president of May-Investments in Grand Junction.

A lower rate of return can be a positive development, May says, because as interest rates for loans rise, bondholders see lower rates of return. Such “normalizing” of the market can be a good outcome this year, he adds.

In an interview with the Business Times, Faulkenberry says the bond market has enjoyed a decade of solid returns, making the recent lower rates an even poorer investment by comparison. The market should now prepare for a long run of modest returns, he says.

“I think we’re in a 10- to 15-year bear market,” he adds, noting the yield on 10-year treasury bonds has fluctuated between 2.5 and 3.5 percent in recent weeks.

“Some economists are indicating a bond bubble could be coming,” says Carol Skubic, market president for Vectra Bank in Grand Junction. Skubic says she’s keeping a close eye on the situation as she fields questions about the possibility.

For clients who have concerns, Skubic offers the same advice as many of her peers. “If you have concerns, schedule an appointment with your financial advisor.”

As is the case with many financial predictions for 2011, there are some unforeseen possibilities that could send the market into turmoil.

“We could see poor rates of return for a long time, and that’s not even counting the default risk,” Faulkenberry says. “If we don’t get our house in order, we could be like Greece.”
Greece is trying to turn its economy around after amassing large amounts of debt and relying on other European nations to keep it financially afloat.

Faulkenberry and others hope the U.S. isn’t headed down the same path.