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Sept. 28, 2012, 12:02 a.m. EDT

The 3 most overvalued assets today

Commentary: Bond bubbles blow as investors dump stocks

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By Howard Gold

NEW YORK (MarketWatch) — Stocks have sold off since Federal Reserve Chairman Ben Bernanke told the world it would be open season on risky assets as long as he’s in charge — and maybe even beyond.

The Fed’s plan to buy $40 billion worth of mortgage-backed securities a month indefinitely may change investors’ calculus, but it doesn’t change the fact that many asset classes are wildly overvalued. And they all have one thing in common: They’re beneficiaries of a frantic search for yield over the past few years.

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Since 2007, investors have dumped $500 billion worth of U.S. stock funds and poured more than $1 trillion into bond funds even as rates have plummeted and the Standard & Poor’s 500 index has doubled. That has led to much speculation about a “bond bubble.”

If there is one, it hasn’t burst yet; in fact, it just keeps getting bigger and bigger, driving my candidates for the three most overvalued asset classes to even more stratospheric levels. Here they are:

1. Long U.S. Treasury bonds could be the Mother of all Bond Bubbles

Yields plunged from 5.25% in June 2007 to an all-time low near 1.4% in late July as the global financial crisis and recession pushed the Fed to cut short-term rates near zero and use unconventional measures (so-called quantitative easing) to boost the struggling economy.

Bond prices, which move counter to yields, have soared, making 10-year Treasurys an expensive bet right now. But I wouldn’t short them or avoid them completely — remember what happened to Pimco’s Bill Gross?

In August, long-time bond bull Gary Shilling told me he expects yields on the 10-year to fall to as low as 1%. That would be a big move from the current 1.6%, but remember, he said a new U.S. recession already has started. If you don’t believe that, then the 10-year may not go much below its July lows.

Read why Gary Shilling thinks the U.S. is in a new recession in MoneyShow.com.

2. Treasury Inflation Protected Securities

TIPS have been popular as a hedge against future inflation. TIPS are Treasurys that adjust their principal and interest based on changes in the Consumer Price Index. When inflation rises, so do semiannual interest payments; they fall when there’s deflation.

The iShares Barclays TIPS Bond ETF /zigman2/quotes/200600110/composite TIP +0.15%  is near its all-time high above 122. That’s a 33% gain since October 2008, when it changed hands at around 92. Vanguard Inflation-Protected Securities fund /zigman2/quotes/207983017/realtime VIPSX +0.27%  has had a similar trajectory.

But when you subtract inflation from the bond’s coupon rate, TIPS now have negative yields — 10-year TIPS sold at -0.75% in the last auction. So, you’re paying the federal government a pretty penny for future inflation protection. And if rates rise, the value of TIPS’ principal will fall, just like any other Treasury.

Bond maven Marilyn Cohen, founder and CEO of Envision Capital Management in Los Angeles and author of “Surviving the Bond Bear Market,” said TIPS are pricing in “negative yields going out to 2032.” Yet, she adds, “people who have continued to stay in TIPS have done nothing but print money.”

I certainly wouldn’t buy new TIPS now, but Cohen said, “If you own it, hold it,” especially if you have a small position (less than 5% of your portfolio).

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