June 11, 2010 – Don’t Get Sucked Into the Bond Bubble Either

Featured Trades: (SHY), (TUZ), (TBT)
PIMCO 1-3 Year U.S. Treasury Index Fund ETF
ProShares Ultra Short Lehman 20+ Year Treasury ETF

4) Don't Get Sucked Into the Bond Bubble Either. I hate to see retail investors buy bubble tops because they work so hard for their money, it's a pity to see it all disappear like a puff of smoke. That is exactly what is happening with bond funds now. We are near the top of a 28 year bull market in government bonds, and a piper has to be paid in the not too distant future. Yes, I know you have heard all of this before, with numerous advisors ringing the bell over our exploding national debt and the hyperinflation this is bound to bring. On this front, I have been just as guilty as the rest. Last year, a staggering $375 billion poured into bond funds, a record, while $40 billion exited equity funds, despite a Dow that rose 23%. Many investors are suffering from a false sense of security that if they just hold bonds to maturity they will suffer no loss. If you are holding the bonds outright, which often come in $1 million round lots, this is true. But do you really want to hang around for 30 years? And if you have your nest egg hiding in bond funds, you are running more risk than you realize. Funds have management fees and administrative costs that come out of your hide, which, if added up over several years, can amount to quite a bit of dough. When the market turns, individual funds may suffer liquidity problems. If you are the typical individual investor with a 50:50 bond/equity split who has somehow stumbled across this letter, it's time to make some adjustments to your portfolio and cut your risk. Here are four suggestions, ranked by a rising level of risk tolerance: 1) cut your bond holdings and increase you cash, 2) keep the same 50:50 ratio that lets you sleep at night, but shorten the bond duration from long to short term. That means selling ten and 30 year bonds and funds and buying those with three year maturities, 3) cut your bond exposure and increase your equity holdings. Good candidates for this move would include the iShares Barclays 1-3 Year Treasury Bond ETF (SHY), and the PIMCO 1-3 Year U.S. Treasury Index Fund (TUZ). For the most aggressive willing to make a leveraged short play, there is always option (4), the ProShares Ultra Short Lehman 20+ Year Treasury ETF (TBT), which is trading just above its 2009 lows . Don't call me wrong, just early.