A chorus of top hedge fund managers recently renewed their predictions that the bond markets are riding for a fall. They don’t say when, but given these gurus’ tone, we can assume they think soon.  If true, the crash will come fast and furious, and just as with a stock market crash investors won’t have time to sell, except at fire sale prices

I thought about this on a recent visit to Miami’s region’s financial district, Brickell, which some call the financial capital of Latin America. Brickell has had a condo housing boom for the last few years as rich Brazilians, Argentinians and Venezuelans have used beachfront condos to store wealth when their currencies were strong.

The problem is that there was no constraint on beach condo development, just as there is no constraint on issuing bonds. So there is a condo surplus the likes no one in South Florida has ever seen. And at least seven towers are still in the building phase, by my count.    

But now that the currencies in Brazil, Venezuela and Argentina have declined since their highs last year, we’re seeing a slow motion bubble burst, and that property is looking like the new Miami Vice.  Those same condo buyers need cash as their situations worsen back home, so they’re starting to sell, and as the selling increases, they have to slash prices to make a sale. Miami residents I spoke with say a huge condo crash is coming next year.

They sound just like those hedge fund managers predicting a bond market crash.

In a letter to investors this month, as reported by CNBC, hedge fund manager Paul Singer’s Elliott Management called the bond market broken and “the biggest bond bubble in world history.” He warned investors buying up bonds that have small or negative yields. “Hold such instruments at your own risk; danger of serious injury or death to your capital!” Singer wrote, adding, “the ultimate breakdown (or series of breakdowns) from this environment is likely to be surprising, sudden, intense and large.”

Meanwhile, Janus Fund manager Bill Gross has made similar statements, using equally apocalyptic language. In early June he wrote on Twitter, “Global yields [are the] lowest in 500 years of recorded history, [and there are] $10 trillion of negative rate bonds. This is a supernova that will explode one day.” Gross believes low rates, rather than spurring economic growth, are promoting asset bubbles that will eventually pop.  

These alarms haven’t phased investors, who keep buying bonds, even ones that pay you back less than you put in. August the value of negative yielding bonds increased to $13.4 trillion, according to the Financial Times. And that in itself—a willingness to ignore obvious signs of problems—is another sign of a bubble.

How to Prepare

But again, when will the bubble happen?

The closest thing to timing has been the shared belief that the trigger for such a fall could be when central banks fail to reverse another market or economic downturn. 

I think that the trigger could be when corporations or governments decide to compete for income investors and offer higher yields on new debt as investor appetites for thin or negative rate bonds wane, or other higher income alternatives develop from non-financial firms and drives competition.   

My advice: Trim your bond portfolios, particularly those bonds that have gained in the recent bull market but offer yields that are too low to offset any major loss of principal. And trim bonds considered high risk, such as high yield or “junk” bonds.  They’ll fare particularly badly in a weak economy.

And consider replacing those bonds with dividend-paying stocks. Some conservative stocks such as utilities or healthcare stocks offer 3% to 5% dividend yields, versus scant or negative bond yields. So be sure to check recommended income stocks in our Utility Forecaster letter and our Personal Finance letter—I’ll be starting to manage the PF Income portfolio next month.