What Happens Next?: The Global Bond Market Will Be The Biggest Asset Bubble To Bust Of Our Lifetime

If bonds were routinely quoted in price, instead of yield, like the Internet stocks of 1999, or the housing market of 2007…EVERYONE would understand that we are heading for a major crash in the global bond market.

There are now an estimated $11.7 trillion of global bond securities trading at unprecedented record all-time low negative interest rates (below 0%) and unprecedented record all-time high prices. This staggering figure, now 26% of all government debt outstanding in the world, continues to soar even higher by the day, now up a whopping 12.5% since the end of May just one month ago.

To put this into perspective, $11.7 trillion is larger that the total market capitalization of the entire list of companies trading on NASDAQ combined and greater than the entire stock market capitalization of every major exchange on the European continent combined.

Global bonds are trading at nosebleed prices where many investors (lenders) are paying interest on their own capital to bond issuers (borrowers) just for holding their cash.

Investors who follow the simple economic law of supply and demand should be equally alarmed. The Bank for International Settlement (BIS) has reported that the size of the global bond market now exceeds $100 trillion – up over three-fold from 2000. Bond prices back in 2000 were significantly lower than they are today.

Case in point: If the supply of widgets, or dotcom stock valuations, or houses on the market grows exponentially over time, one would reasonably expect the prices of those assets to fall over time. Right?

Wrong, at least for now in Global Bond Land.  Go figure.

There is a history lesson for all of us here too. Sovereign debt crises, culminating in significant government and public sector bond defaults and restructurings, have occurred for centuries – you just have look back far enough to find them. As large percentages of both emerging market and developed nations’ debt went into default, interest rates and underwater assets spiked dramatically. This result produced a negative economic feedback loop that deepened the crisis for countries dependent on external funding. (Chart 1)

Chart 1

A prime example of the current Bubble-mania within the global sovereign debt marketplace would be the bull market euphoria in Eurozone government debt. The Government of Italy long term sovereign paper (10 year maturity) is now trading at a minuscule 1%, down from over 7% back in the Greek Debt Crisis of 2011-12. Prior to the beginning of the Eurocurrency in the late 1990s, Italian bonds (denominated in Italian Lira currency) traded at yields of over 14%. By comparison, USA’s 10 year government debt traded at 6% yields during the same time frame.

The lunacy of Italian government bonds now trading at such low interest rates (record high prices), is that Italy’s government debt-to-GDP ratio has ballooned in just the past few years. With a current debt/GDP of 135% today, up significantly from 115% four years ago, Italy’s own high grade credit rating is now hanging by a thread as bond supply increases while economic growth deteriorates.  (Chart 2)

 

Chart 2

 

With Italy’s credit rating just one notch away from junk bond status (BBB/Baa2), comparing it to higher quality sovereign debt of other nations makes this mispriced market all that more ludicrous. AAA-rated USA 10 year government debt, still recognized as the world’s safest haven, is currently trading at a significantly higher yield (1.5%) than weaker credit Italian debt of the same maturity.

Also problematic for today’s volatile European financial markets are the transformational political and social trend changes now underway within the region. With the anti-establishment, Eurosceptic ‘Five Star Movement’ political party making major gains in country-wide mayoral elections throughout Italy last week, one could only imagine what would happen to Italy’s government bond market if a ‘Italexit’ was successful in The Boot.

Lookout below.

Chart 3 :  NASDAQ Market Bubble To Bust: 1999 – 2001

 

Human behavior and bubble psychology has been relatively consistent throughout world history with the only variable being the specific asset class involved at the time. If you recall, in the heat of the Internet Bubble back in 1999, a search engine named Yahoo traded with a PE ratio of over 1700X and total market capitalization higher than the three largest US automakers combined.

We all know how that story ended just a few short years later, and today’s global sovereign and public sector debt bubble will end in a similar, wealth-destroying fashion – with most investors wondering why they didn’t see it coming. (Chart 4)

 

Chart 4

 

With a global deflationary economic backdrop and the world’s cabal of central bankers spinning on credit expansionary overdrive, the late-stage market melt-up in global bond prices is a classic bubble market ‘blow-off top’ in process. It is as obvious as any quintessential asset bubble to bust throughout history – from tulip bulbs to housing bubbles.

Unfortunately, unlike the bubbles of recent past, the looming global bond bubble now poses a real systemic threat to the entire global financial system. Brexit and the contagion risk it now presents to the entire European Union and the rest of the world for that matter, is only the beginning of the great bond market unwind ahead.

 

Kirk D. Bostrom
Managing Partner
Strategic Preservation Partners LP

Disclaimer: The views expressed are the views of Kirk Bostrom and are subject to change at any time based on market and other conditions. This material is for informational purposes only, and is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented in this article has been developed internally and/or obtained from sources believed to be reliable; however, the author does not guarantee the accuracy, adequacy or completeness of such information.

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