A ‘perfect storm’ has kept inflation down and bonds more attractive than they normally would be, but as the winds die down, bondholders could be the first to sink, says Anthony Mirhaydari of MSN Money in this exclusive interview with MoneyShow.com.

We are seeing lots of action in global bonds. Are we at a bubble?

I think so. I think you look back over the last 30 years, and fixed-income—bonds—have been the asset class to be in. Even over the last ten years—I mean, equities have been flat.

And bonds outperform them, right?

They have. That’s kind of a historical anomaly. You don’t really see that. There has been kind of a perfect storm of conditions to create that.

Isn’t it a lot of it due to the stimulus, the massive stimulus that global governments have poured in trying to get us out of this recession?

Right. It’s been a combination of factors:

  • One, inflation has been kept in check since the 1980s;
  • Two, you’ve had a big influx of savers from Asia and elsewhere funneling capital into the developed world;
  • And three, we had inflation, we had a glut of savers and then we had kind of a dearth of investment opportunities. So all those factors have pushed down interest rates and pushed bond prices higher.

Now, some of those supports seem to be either ending or are going to be pulled away—particularly, the stimulus here in the United States can’t last forever.

Right. QE2 looks like it’s probably going to be the last of what they’re calling conventional stimulus policies...

In one of the columns I wrote a few months ago for MSN Money, I talked a lot about the end of this global savings glut, as capital becomes more expensive.

This is the situation that business people and investments haven’t lived through in a generation, where money is becoming more expensive. You have to go back into the 1950s, after we came out of World War II, when the Fed was keeping interest rates low to support the war effort.

Then you had this long generational shift where money became more expensive, and interest rates climbed for the next 30 years—and I think that’s what we’re on the cusp of now.

And we certainly know that higher rates and higher inflation are the bane of bonds, whether it’s the United States or anywhere.

You see that, but what can investors do? What should they be doing?

The first thing is avoid bonds where possible. You just don’t want to be in that asset class as money gets more expensive.

At least not buying now.

Right. I mean, when interest rates are high and they’re getting ready to fall, that’s when you want to be in bonds. When they’re low and their getting ready to rise, you don’t want to be in bonds.

With that said, investor risk appetites are different. If you’re an older investor, you’re going to want to be in bonds.

To get some sort of income.

So the first thing is avoid if possible—and if you have to be in bonds, move into the shorter end. Reduce your duration exposure, so that way your exposure to interest-rate changes is lessened.

Outright bonds, mutual funds, or ETFs? Do you care?

If you own an actual bond, you’ll be affected a little bit less, because you’ll be collecting your coupons. If you’re in a bond ETF, you’ll be hurt. You’ll collect your dividend but any capital price changes are going to be to the downside.

One thing that investors should think about is, yes, you’ll get, say, 4% on your yield to maturity on a bond or a bond fund—but you have to factor in if inflation is rising, what your real return is going to be. If inflation is 4% and your coupon is 4%, you’re going to be getting nothing.

And if investors start getting their money out of mutual funds, that’s going to even increase the downside pressure.

Right, exactly.

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