Beware of bubbles

A bubble occurs when market prices are inflated beyond their real values. This has happened with the property market, stock market and more recently, with the commodity market, oil market, China stockmarket and India stockmarket.

All bubbles will lead to a collapse. All the markets mentioned above have collapsed.

Many people may not realise that there is another safe market that is in a bubble. It is the Government bond market. Due to risk aversion, many people put their money in long term Government bonds. The excess demand has pushed up the price and reduce the yield.

If the long term yield for safe Government bonds should be 4% (to cover inflation and cost of money) and excess demand causes the yield to drop to 2%, the price has gone up by about 25% in the case of a 15 year bond. If the yield returns back to the real value of 4%, the price will drop by 20% to get back to the normal level. It is possible to have a bubble in safe investments as well.

If you are caught with long term bonds yielding 2% (and the market price has dropped by 20%, you still have the option of keeping your money at the low yield of 2% for the 15 years).

Lesson: Avoid bubbles. Avoid paying a high price for your investment. Take a long term view.