Stocks and Bonds: What Does the Future Hold
A lot of noise is being about the economy improving and even if things do continue to get better, there is a rather strong headwind building on the horizon. Interest rates have been slowly but surely rising over the past few months and given the current trend, it appears that the bond market has nowhere to go but down.
Our ballooning debt and inflation are labelled as the main culprits.
“Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”
The housing market which experts state has just started to recover (our personal opinion is that it’s a long way from mounting a sustainable recovery) is going to be the first one to get knocked down and dragged down for years to come. Mortgages rates are trading close to 52 week new highs and given that the Fed has ended its $1.25 trillion programs to purchase mortgage debt, rates will be subject to even more upward pressure.
Stocks and Bonds: Yields have been rising for some time, so what’s next
The above chart clearly illustrates that bond yields have been rising for quite some time and one can quite confidently state that mortgage rates have bottomed. The Green circle represents the madness that hit the bond markets when investors panicked and flocked into bonds in late 2008 to the early 2009 period. If rates can stay above the 4.75-4.90 ranges for 12 days in a row or close above this level twice on a weekly basis, it will mark the beginning of a new bull market in rates and long bear in bonds.
Christopher J. Mayer, a professor of finance and economics at Columbia Business School goes on to state “Each increase of 1 percentage point in rates adds as much as 19 per cent to the total cost of a home”. Thus any hope of a long term recovery in the housing sector is going to be short-lived as higher rates will effectively lock out more and more individuals from purchasing a home.
Factors that will create further pressure on bonds and the economy
Auto loans are going to become more expensive; in fact, rates have already been rising. Higher rates here will, in turn, have a negative impact on the auto industry and this short-lived spurt of higher sales could soon be followed with a prolonged drought.
The credit card industry is another sector that is going to take a hit. Rising rates are going to make already skittish consumers even more reluctant to take on new debt. As our economic growth is based on consumers taking on more debt, this will knock the fragile recovery right of its feet.
Washington will soon have to pony up more when it tries to borrow the money it needs for the social programs it has in mind. The outflow of funds from the bond into other investments is also contributing to the rise in rates. If bond investors were to panic and dump bonds, it could have a massive impact on rates. China has been a net seller of late, and if China started to aggressively unload its holdings, it could result in a complete meltdown.
Bond king has reduced Holdings
Bill Gross the bond king has reduced US bond holdings by a significant amount; 9 months ago PIMCO total return fund had invested over 50% of its assets in US debt, today the ratio has dropped to roughly 30%. This is the lowest level in the fund’s 23-year history.
2 weeks ago the Treasury auctioned off $82 billion in debt at a rate of roughly 4%. This is twice as much as they paid towards the end of 2008 and early 2009 when investors flocked into Bonds looking for safety. Full Story
One should definitely pay attention when one of the Fed heads starts to talk especially when what they have to say actually makes sense. It is now 2010, so the figure is now definitely well above $100 Trillion. Add in the $1 trillion health package, and all the other social programs announced since and the number goes up even more.
Conclusion on Stocks and Bonds
For now, bonds have nowhere to go but down. The bond market is a disaster waiting to happen. At some point in time, it is going to experience a horrific correction/crash as the only way this government will be able to borrow the billions and trillions of dollars it will need one day is by paying huge interest rates to bondholders.
Long term players can use rallies in the bond market to short bonds via TBT. Precious metals perform very well in a high rate environment so an even better option would be to have a position in Gold and Silver bullion. One must also seriously consider the possibility of hyperinflation; under this scenario having a stake in precious metals is an absolute must, for they will at least prevent you from ending up in the dog house.
If I had a formula for bypassing trouble, I would not pass it around. Trouble creates a capacity to handle it. I don’t embrace trouble; that’s as bad as treating it as an enemy. But I do say: meet it as a friend, for you’ll see a lot of it, and had better be on speaking terms with it.
Oliver Wendell Holmes, 1809-1894, American Author, Wit, Poet
References
The Crowd, A Study of the Popular Mind: Gustave Le Bon, http://www.gutenberg.org/ebooks/445
Five warning signs of market euphoria, Investopedia, https://cutt.ly/rslGnYU
Impact of Mass Media Use on Youth. NCBI Resources, https://www.ncbi.nlm.nih.gov/pmc/articles/PMC2792691/
6 reasons why most people lose money in the stock market, theladders.com, https://www.theladders.com/career-advice/6-reasons-why-most-people-lose-money-in-the-stock-market
What is mass hysteria, Medical News Today, https://www.medicalnewstoday.com/articles/322607
Random Walk Down Wall Street, Burton Malkiel, https://cutt.ly/5slKVMl
How a cat & some Monkeys Outperformed experts, The Fool, https://bit.ly/2ZYQljy
Russian Chimpanzee outperforms 94% of Bankers, Dailymail.co.uk, https://www.dailymail.co.uk/news/article-1242575/Lusha-monkey-outperforms-94-Russia-bankers-investment-portfolio.html
Other articles of interest
Anatomy of a Housing Crisis (April 16)
The Engineering of A financial Crisis
The Art of Becoming a Better Investor
The Fannie May and Freddie Mac debacle (March 29)
The competitive currency devaluation era gains momentum (March 25)
A small but Strategic victory for Google (March 23)
Palladium; the Stealth bull Market (March 22)
The Devalue or Die era is picking up steam (March 16)
Euro Woes Part II (March 14)
Lack of Interest in Gold ETF could lead to a strong correction (March 13)
