Bubble Bubble Toil and Trouble?

Lots of talk out there these days about bonds being in a bubble.

Notable example: Mr. Stocks for the Long Run, Jeremy Siegel, thinks bonds are in a bubble.

In fact, he thinks that those "who are now crowding into bonds and bond funds are courting disaster". His version of disaster is that bonds could lose 3x their current yield, or about 8% or 9%.

Never mind that if you hold to maturity, you will not lose money (like you can when an equity market bubble bursts), you will receive your coupon payments and get your full principal back.

Siegel is the guy who in January said:

I don't see it being a good year [for bonds] in 2010, because the Fed will be forced to raise interest rates sooner rather than later. We will see bond rates move higher.

Well, he was right... for a time. The 10-year yield did indeed move higher from just above 3.6% at the time of his interview to nearly 4% in April.... but have now rallied to under 2.6%.

Nor will he will be right about the Fed.

And he thinks that the p/e multiple should be at around 20 times normalized earnings "because of efficiencies in the market".

At no time in history when the stock market has had a 20x normalized P/E did you end up with an attractive long-term return on a going-forward basis. Normalized P/Es have exceeded 20 in the 1900s, the late 1920s, the 1960s and the 1990s; and we know how the following decade turned out in each case.

Consider the following chart, which shows what average and median price returns were 10-years forward from experiencing a normalized P/E in each range (using data going back to 1900)

anything over 18 has been hazardous to your wealth; would you accept a (nominal) return on stocks of just 1-4%?

by the by, the normalized P/E on the S&P right now is at about 22

so, he thinks bonds could lose as much as 10% if yields go higher; what does he think stocks might lose?

well, he doesn't say; but the normalized P/E of its high level currently of 22 compares unfavourably to a historically average level of 17 or 18, implying that stocks are currently 25% to 35% over-valued

which perhaps explains why investors are willing to bid bonds up to current levels

I'd rather take on the relatively low probability (given the economic environment and the likely course of monetary policy, both traditional and unconventional/quantitative) of a potential 10% loss on bonds as opposed to the (in my estimation) higher probability of as much as a 30% loss on stocks.

Or, as Felix Salmon says,

Most bond investors would love nothing more than for the Jeremys to be proved right and for stocks to start rising impressively as the economy recovers — even if that means losing money on their bond investments. But if the economy gets worse, having your money in safe Treasury bonds is going to help you sleep a lot better than having it in risky and volatile stocks

but let's say that maybe Siegel is right in a sense; maybe the current level of yields IS unsustainable in the long run, and, as such, bonds ARE in a bubble; but perhaps its a VERY long run (Japan's bonds have been in a bubble for 15+ years, I guess, with no signs of it abating yet), and bonds are in an unpoppable bubble, as per Colin Barr of Fortune.

Or, as per the Pragmatic Capitalist, the great bond "bubble" is a myth.