The Next Big Bubble

03/29/2010 11:58 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Marilyn Cohen of Envision Capital Management says the next bubble is here in a very surprising place-bond funds.

MoneyShow.com: Where is the next big bubble, Marilyn?
Marilyn Cohen: I think that the bubble is here, and it is in the bond fund area.

Q: Bond funds. Isn't that where a lot of individual investors have been pouring their money to stay away from stocks for the last year?
A: It has been a stampede as opposed to a pouring. When the credit crisis hit, individuals said, "Get me the heck out of stocks! I do not care; I have had it."

And where did they go? They could not go to money markets. Those yields were too paltry. CD yields had declined dramatically, so they went in to bond funds of all shapes and all sizes: high-yield funds, Treasury funds, TIPs funds, municipal bond funds-you name it, and we have seen the flow of money continue, and I think this is the big bubble. It has formed, and it is getting larger and larger, and I think therein lies the peril.

Q: So, what is the peril? Under what scenario could this bubble actually burst?
A: Oh, how about rates finally moving up? How about the stock market finally sucking some people back in?

Individuals have not been net buyers of stocks, and, you know, in mutual funds, selling begets more selling. So, if you are in a bond fund that you start seeing liquidations, the fund manager has to sell more bonds in order to give people their proceeds and you just start seeing an avalanche.

Another thing, take a look at the majority of bond funds. They have reduced their dividends, so people that bought bond funds to lock in their yield, they did not lock in anything, because the more money that comes in to those funds-and it is continuing-the fund manager has to buy lower-yielding bonds at today's level, and it dilutes you, the bond fund holder.

So, I think it is the worst of all possible worlds. It will probably get a lot worse before that bubble pops, but I am very, very worried for the individual investor.

Q: So, what should people do know? Should they not put more money into the funds? Should they be gradually reducing their exposure?
A: The answer is yes and yes. They should not be putting more money in bond funds. They should put money in some individual bonds [of companies that] have good balance sheets and the wherewithal to make timely interest and [where] principal payments are very good-bonds that they understand what the company does; and they should take some profits off the table in their bond funds.

People that bought bond funds over the last 13-14 months have huge profits. They need to take some off the table. If they have exchange traded funds, they need to put some stop losses in and admit success. You do not get whiplashed.

Q: Thank you.

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