Published August 31, 2012
It's real simple.
If German Chancellor Andrea Merkel makes the decision to start doling out money to help Europe's bankrupted countries and banking systems or if somehow the economies start to improve on their own, we will see a sharp selloff in the U.S. bond market.
Bond investing 101 teaches us that when bond prices go up, yields go down and vice versa. If things start to look better, the selling will be quick.
It is important to recognize that our government and municipal bond markets are grossly overpriced due to the panic buying of our bond markets every time Europe looks to be on the brink of collapse. We are, and continue to be, the world's safe haven. With August giving us a slight reprieve when all of Europe went on vacation, we saw bonds give back some of their rapid and torrid gains from the previous months.
If you are an investor who own bonds that were purchased over two years ago, you should have nice gains in the principal amount and be enjoying nice income from the holding. I suggest that you immediately ask your financial advisor to do a yield-to-maturity calculation from today's price; this will tell you if you should lock in your gain or not .
I believe most of you will see that although you may be receiving a nice yield from the bond, after deducting the reduction in the price of the bond as it gets closer to maturity, you will see that your yield to maturity is between 1% and 2% per year.
That’s right -- even though your coupon may be 5% a year, the appreciation in the principal amount on the bond brought on by the panic and fear in Europe will soon evaporate. This happens as the maturity date gets closer or when rates rise . You will see interest rates rise when the economic picture in Europe and the rest of the world starts to look even the slightest bit better .
Would you buy a security that only has between a 1% and 3% upside and is 30% overvalued? Not a chance!
As the old adage on Wall Street goes, "If you wouldn't buy a security today, then there is no reason to hold it. "
You aren't being paid to play the bond market today.