Did Bonds Just Peak?

Commentary: Bill Gross's mea culpa sounds like capitulation

They say the time to sell is when the last bear turns bullish.

When it comes to U.S. Treasury bonds, did that just happen?

Bill Gross, the world's most famous bond manager, has now fessed up that he made a blunder when he turned bearish on the bonds last winter. Gross says his bet against Treasurys was a "mistake" and that he had been "losing sleep" over it this summer. Read the story about Gross losing sleep on the Wall Street Journal web site.

Treasury bonds have been booming to higher and higher prices for months, as fears have grown of a new recession and a deepening financial crisis.
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Bonds work like a seesaw, so when the prices go up, the yield, or interest rate, goes down. Today the interest rate on 10-year Treasury notes has plummeted to just 2.2%. The 30-year bond pays a mere 3.5%. These are at, or near, historic lows.

The "real yield" on inflation-protected Treasuries, known as TIPS, has collapsed as well. Short-term TIPS now lock in a guaranteed loss of purchasing power. Even long-term TIPS don't pay you much over inflation.

In the circumstances, it's easy for commentators to throw rotten eggs at Gross.

But successful investment management is like successful poker playing. It isn't about predicting the future. It's about understanding the odds -- and the other players. And when Gross got out of Treasuries he was making a reasonable decision, based on the prices at the time and the scenarios in front of him.

Uncle Sam is basically broke. The national debt, which was $3 trillion a generation ago, is up to about $15 trillion. Within five years it is forecast to pass $20 trillion.

More importantly, our political system has become a farce. Neither party has any serious intention of dealing with the deficit. Witness the childish and surreal attitudes toward taxes and the Pentagon.

The "super committee" created a month ago is just a feel-good bedtime story you tell to children, which is who we now are.

In the circumstances the only recourse left is for Ben Bernanke to clip the coins -- in other words, to print more dollars to cover the shortfall.

Sooner or later that is going to smoke bondholders. It has already trashed the U.S. dollar.

Why would anyone lend to such an entity for 30 years at 3.5% interest? Or even for 10 years at 2.2%?

As the late Herbert Yardley once wrote, in the classic "Education of a Poker Player," I wouldn't bet on that hand with counterfeit money. You're taking on the risk of a big loss in return for the hope of a small gain.

If you're playing your hand on behalf of widows, orphans and other bond-fund investors, you don't try to bluff too often. And you don't draw to an inside straight.

Why have Treasuries boomed?

I suspect there are three reasons.

First, investors around the world still believe in the American Empire. They haven't worked out that the game is up. And so when they smell crisis they still run to the Treasury market.

Second, many investors here are still hung up on Modern Portfolio Theory, which tells them aging Baby Boomers should be buying more bonds, regardless of the price. Every month they sock more money into their bond funds, merrily trusting that "bonds are safe." Tell that to anyone who bought government bonds in the Fifties, before the great inflation. Tell that to anyone who has lent money to any number of European governments -- from Greece to Ireland to Italy.

The third reason? Many private investors are succumbing, once again, to the biggest single mistake in the markets -- performance chasing. In effect they are saying: "Look -- bonds have done really well, so we should get on board!" You may be surprised that anyone could be so foolish, but believe me, an amazing number of investors really do think that way. The momentum can even make them look good -- for a while.

Diehard bears argue that US Treasurys will keep rising, just as Japanese Government Bonds did in the Nineties, to the point where long-term yields fell below 1%.

But there are problems with that analogy. Yes, the Japanese government ran huge deficits while its bonds boomed. But Japanese society didn't: The country ran a trade surplus every year, and households saved and saved. The contrast with the ailing American Empire could scarcely be more stark.

If you want to own government bonds, you're probably better off buying them from a country with a grown-up political system. Norway's bonds actually pay a higher rate of interest than Treasuries -- and Norway has a balanced budget, and no national debt. No kidding.

Brett Arends is a senior columnist for MarketWatch and a personal-finance columnist for the Wall Street Journal.