We who claim to understand markets, and occasionally get it right, could see the folly in buying or holding a 10-year Treasury bond when its yield fell to as little as 3.1%. That was in June. Now it's August and the 10-year Treasury yield has bounced to 4.5%. Should you bite? Not yet.

Five danger signs

1 | Back in June, about a week after the 10-year Treasury yield hit that 43-year low, I attended a famous investment conference run by a firm known for its mutual fund data. Every financial planner and portfolio manager I met there, and I met lots, was excited about stocks and the economy for the rest of 2003 and 2004. They were negative on bonds, dumping real estate investment trusts, and down on cash and CDs except as regular savings and emergency reserves. Bond math says there's a big difference between collecting 3.1% and 4.5%, but when people smell 10% and 12% returns in stocks for the first time in ages, both those yields are puny.

2 | We're at the end of second-quarter earnings season and it has been pretty good. What I remember most is that all kinds of companies are using their profit reports to announce a substantial rise in dividends. If you can get a 3% dividend yield from Exxon Mobil (XOM) or Merck (MRK), whose shares are also likely to appreciate over time, why accept the same from a bond? Dividends aren't going to move up one time only and stop. As earnings grow, so will dividends.

3 | Maybe we haven't seen the proof yet, but didn't someone in a position to know -- that would be the Congressional Budget Office -- pass the word a little while ago that the U.S. government will collect $400 billion or so less in taxes and fees than it is going to spend in 2004? (And that's without a full awareness of the costs of occupying Iraq.) The Treasury surely isn't going to borrow any less money. It is certain to borrow more. Right now, the U.S. is set to auction around $60 billion at various maturities. I can't imagine investors will be so supine as to accept really low yields.

4 | There are signs that the economy is growing faster than it has for several years. Under normal circumstances, the stronger the economy, the greater the demand for credit, and thus the cost of credit - interest rates -- rises. Remember, the relationship between bond prices and interest rates is an inverse one. That is, for yields to rise, prices have to fall. If you buy now, your money would be tied up in a 4.5% bond while new issues offer 5%, 6% or more. That leaves you with the decision to hold onto your 4.5% bond for the full ten years, or sell it at a discount later.

5 | While people don't buy municipal bonds for the same reasons as they do governments, the yields on munis (even allowing for lower tax rates) are extremely attractive.

When 4.5% looked good

Now let's cycle back to the last time a 10-year Treasury bond traded to yield 4.5%. That was July 2002. The economic news at that time was awful. The Dow industrials were below 8000 and fear was widespread that the bottom was nowhere in sight. If there wasn't an actual recession going on, it was close. There was no tax cut yet on dividends, and bank deposit rates weren't much better than today. So people had a fistful of reasons to seek sanctuary in Treasury bonds. A year and a month later, they don't.

I can't say, because no one can, whether the 10-year yield will level off at 4.5%, or at 5%, or 6%. But, in any event, with all the reasons to put money in other places, the Treasury bond market -- at least at the long end -- looks problematic. Once that changes, I'll scream it out.

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