The Bond Bubble Will Soon Burst

04/09/2012 10:45 am EST

Focus: BONDS

Joan Lappin CFA

Chairman and CIO, Gramercy Capital Mgmt. Corp.

The 30-year run in bonds is very close to its end, says Joan Lappin, who explains the catalyst and how investors can protect their portfolios against this shift in the investing landscape.

Should you be in bonds? We’re asking that question today with Joan Lappin. Joan, if people do feel safe in bonds, do you believe that perhaps that’s a mistake in impression?

I do, and the reason people feel safe is quite simple.

We have some long-term charts available that go back 100 years really, and they show that in the period from 1941 to 1981, interest rates were rising from a 3% or 4% level where they had been for a long time, up to a peak of a Fed Funds rate of 19.2%. So for 40 years, owning a bond was not a very good thing to do.

Since Paul Volcker was chairman of the Fed and pushed rates up to that very high level, they’ve gone in the opposite direction—from 19% to now close to zero or 1.9% something for the ten-year notes.

Basically for 30 years, if you owned a bond, the wind was at your back. I believe we’re going to return to a period like the one from 1941 to 1981, when for 40 years interest rates rose and owning a bond was a losing proposition.

Was this true for not only say US Treasuries, but globally? Talk a little bit about that. I know that you’ve spoken about the Greek…

Well, the chart that we’re providing for the viewers to see is one of the Greek ten-year treasury bond. You can see that that security traded at a very level amount for years, eight years or nine years, until people started to become concerned that maybe Greece would have to default.

We don’t know what Greece is doing—even at this moment in time, after two years of this—but this chart is very telling about what can happen if a country moves into the zone where people become worried about it.

Greek bonds have now lost over 90% of their value, and the interest rate that was 3% or 4% has now risen to more than 30%. So it’s pretty frightening, and I think the chart is a very graphic demonstration of exactly what can happen.

Don’t forget, so far the United States has done nothing about repairing our budget and our deficit and our long-term obligations. I’m not predicting that this is what’s going to happen to the United States. I hope that at some point the politicians in Washington will get their act together and work together with the executive branch, whoever’s filling it, and solve the problem.

In the meantime, what should bond investors be doing, then?

I believe they should be very mindful of the fact that Ben Bernanke has given them an enormous gift in recent weeks and said we are not raising rates until at least 2014. So this bond collapse will not happen before that, but it’s destined to happen after that.

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