Review & Outlook

Our take on the investing, financial, & economic themes of the day

“Bond Buyer’s Dilemma”

9 December, 2011 by Ben O'Brien in Commentary

The economist Burton Malkiel, who happened to be my professor sophomore year in college (Spring 1970!), wrote an article in Wednesday’s Wall Street Journal entitled “Bond Buyer’s Dilemma” that made many of the same points that I have been making for the last year or so. (In the interest of full disclosure let me say up front that I did not do well in Prof. Malkiel’s course, though I am not going to tell you the actual grade. I do have an excuse, though. That was the semester I started dating my wife.)

In the article Malkiel writes:

For years, investors have been urged to diversify their investments by including asset classes in their portfolios that may be relatively uncorrelated with the stock market. Over the 2000s, bonds have been an excellent diversifier by performing particularly well when the stock market declined and providing stability to an investor’s overall returns. But bond yields today are unusually low. Are we in an era now when many bondholders are likely to experience very unsatisfactory investment results? I think the answer is “yes” for many types of bonds—and that this will remain true for some time to come.

The gist of Malkiel’s argument is that things look a lot like 1946 in terms of debt levels and GDP. Back then debt was 126% of GDP; today it’s in the range of 100% and moving higher. The government inflated its way out of the debt in the period 1946 – 1979 at the expense of bond holders.

Today, says Malkiel, the US government (as well as governments around the world) is likely to work down the debt the same way. In response, he says, lower credit quality a bit when buying corporates, buy munis(we did last year when they were cheap), buy dividend-paying stocks, be very cautious about US government bonds. Just what I have been saying. Maybe he should change my grade.

Mark O’Brien