Once Again: Are Bonds a Bubble?

REKENTHALER REPORT: On bubbles, balanced investing and Rekenthaler's latest fail

John Rekenthaler 31 May, 2013 | 4:30PM

What's a Bubble? 

Some popular financial phrases have a precise definition. Bear market, for example, has the strict meaning of a stock-market loss exceeding 20%, in addition to the informal sense of "it seems as if every day is down." Similarly, leverage can be used generally to convey a high level of exposure to an asset, or it can be calculated to the percentage point.

Bubble, on the other hand, resists such precision. To paraphrase former US Supreme Court Justice Potter Stewart, as with pornography, a bubble cannot be measured; instead, we are supposed to know one when we see it. Of course, we often see things in different ways. For example, per some critics of the bond market, the US is now in the midst of a bond bubble, while for other critics bonds are not a bubble, they are merely expensive.

This week, Cliff Asness of AQR offered an update on the definition. A bubble, he said, occurs when there is "no plausible defence for a security's price." Thus, technology stocks in 2000 were a true bubble. There was no credible story that could support NASDAQ's peak price of 5,000. No matter what tricks one played in attempting to defend the stocks' valuations--and trust me, there are always tricks, always different accounting measures to be selected, different comparables to be used, and different analogies to be made--the numbers didn't work. A company here and there could prove to be a good investment, but the industry overall could not be. For NASDAQ to justify its valuation, every tech company had to become the Apple (AAPL) of its industry.

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About Author

John Rekenthaler

John Rekenthaler  John Rekenthaler is vice president of research for Morningstar.

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