According to Jim Jubak, the next asset bubble is here and it’s called the US Treasury market. If one believes in his thesis, then one of the best ways to capitalize on the bubble popping would be purchasing TBT, the Proshares Ultrashort Lehman 20+ Year Treasury (it moves 2x the inverse of the 20+ year Treasury market):
What we’re seeing in the Treasury market is a bubble that has inflated government bond prices. But unlike the technology stock bubble or the real-estate bubble or the mortgage-backed-securities bubble, this one isn’t caused by greed. This is a bubble based on fear: Investors are buying Treasurys to protect themselves against the risk of government default, the risk of sinking nondollar currencies, the risk of market collapse, the risk of rising corporate defaults.
The question now is: How much longer will the fear last? For how much longer will investors be willing to take these low yields on U.S. government paper, knowing all they know about the state of U.S. finances, before they decide that 1) U.S. government debt isn’t as safe as it now seems to be versus the alternatives and that 2) the higher yields of corporate debt justify the risk?
My estimate is that the tipping point will occur later this year — but not all that much later. Moody’s (MCO, news, msgs) and Standard & Poor’s are forecasting that the default rate will peak near the end of 2009. At the same time, Credit Suisse (CS, news, msgs) projects that the yield on 10-year Treasurys will climb 4% by the end of the year, causing the prices of already issued Treasurys to fall. A Bloomberg News survey of the primary Treasury dealers who do business with the Federal Reserve projects a 3.1% decline in the price of the 10-year note in 2009.
That may not seem like much, but with the 10-year note yielding just 2.52%, a drop like that is enough to produce a negative total return from holding a 10-year Treasury.
The combination of the two — the prospect that the default rate on corporate bonds is near a peak and that the prices of Treasurys are about to fall — would send money from Treasurys into corporate bonds. That would, of course, accelerate the fall in Treasury prices and the climb in corporate bond prices. Investors who have been through the past two bubbles should recognize this kind of negative feedback as “lower prices produce still-lower prices.”