Markets

A Bubble Bigger than Housing Is About to Pop -- Here's How to Protect Your Portfolio

The most devastatingmarket events are those that no one sees coming.

Take what happened to the Lehman Brothers in 2008, for example. Up until the last minute, virtually no one could have imagined one of the country's leadinginvestment banks would file forbankruptcy . The housing market crash was the same way. The Street believed housing prices would never go down.

With the market totally blind to the growing risk in each investment, anyone who hadinvestments in housing or with Lehman Brothers suffered huge losses.

Despite these tough lessons, there is now another epic bubble developing and the market is ignoring this one too.

In fact, this bubble is so big, the 2006 housing bubble and the 2000 bubble pale in comparison. And when it pops, itwill hit the most conservative portfolios the hardest.

While investors were burned by big losses in 2008, risk-averse investors have been flocking into the safety of Treasurybonds . In just the past four years, investments intobond mutualfunds have doubled to $4 trillion. But this perceived bastion of safety is more like a ticking time bomb waiting to explode. And when it does, it will devastate any portfolio with a heavy allocation to Treasury bonds.

Here are four reasons why it's time to selltreasuries .

1. Risk and reward

The best reason to abandon the bond market is a simple matter of risk and reward.

With the U.S. Federal Reserve beating yields into the ground in the past four years, the risk-reward ratio in theTreasury market is terrible. If theyield on the 10-yearTreasury note fell to zero from its current 1.9%, then bond prices would rise about 17%, according to Timely Portfolios. On the other hand, if the yield grew 2-3%, bond prices would fall about 20%.

In 1994, at the beginning of the epicstock market rally, bond yields jumped 240basis points in nine months. If that were to happen again, bond prices would plunge 50% and anyone holding Treasury notes would sustain huge losses.

2. Yields have never been lower

According to O'ShaughnessyAsset Management , 2013 could be the most difficult environment in 140 years to generate income. That's because it's the most affordable time in 223 years for the U.S. government to borrow on a 30-year term. In relation to the risk/reward proposition, yields on Treasuries really have only one way to go, and that is up. And when they do, it will have dire consequences for bond investors who think they are making "conservative" investments.

3. Too much debt

Adding fuel to the debate about Treasury yields is the fact that the United States has rarely, if ever, been in a worse financial condition.

On a consumer level, a weak financial profile means higher borrowing costs. But withthe Fed working its magic over the market and artificially pounding yields into the ground, the bond market no longer reflects the financial condition of the United States. For the time being, the country continues to get a free pass from the world and the bond vigilantes for its wild spending and unsustainable fiscal deficits, but acorrection is sure to happen. And when the United States is forced to pay higher borrowing costs due to its unsustainable deficits and ballooning debt, the bond market and its investors will suffer huge losses.

4. The private sector

Although theeconomy is plagued by high levels ofunemployment and slow gross domestic product growth, the private sector has rarely been stronger.Earnings , margins andcash balances are at an all-time high, which makesequities andcorporate bonds attractive alternatives to Treasuries carrying hugecredit and interest-rate risk.

Risks to Consider: There is a classic saying on the Street: "Don't fight the Fed." The Fed is the single most powerful financial institution in the world and remains fully committed to keeping rates down. Although the United States is in horrible financial condition, the market still views Treasury bonds as a safe haven, which could send prices higher if another financial crisis hits the Street.

Action to Take --> Despite the country's battered financial condition, Treasury bonds are still viewed as one of the safest securities in the world. But with a terrible risk-reward ratio, growing fiscal deficits, record-low yields and attractive alternatives, the Treasury market is ripe for a long overdue correction. That's why it is time for forward-thinking investors to sell their Treasury bonds and protect their portfolios from huge losses.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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