Watch Out! There’s a “Bond-fire” Going on in Fixed Income

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There’s a “bond-fire” going on in fixed income, with government debt from one end of the globe to the other getting torched.

Take the iShares 20+ Year Treasury Bond ETF (TLT), which tracks the price of long-term U.S. Treasuries. It has lost more than 8% of its value just since mid-July. bonds-screen-918x516

At the same time, 30-year government bonds in the U.K. have dropped almost 12%. That’s despite the Bank of England’s recent decision to ramp up its bond-buying plans.

Germany’s benchmark 30-year bond just fell to its lowest price since June. And yields, which move in the opposite direction of prices, have surged. Japan’s 30-year bond yielded just 0.04% in early July. Now it yields 12 times as much – around 0.49%.

What’s driving this move? I see three major catalysts:

  1. Fears of rising inflation, driven by a rebound in the price of energy and other commodities — When inflation increases, it erodes the value of the fixed payments bonds provide. So the price of government bonds has to adjust lower to reflect that.
  1. Worries that central banks will back away from QE – There is no logical reason for bonds to “yield” less than zero. But more than $14 trillion in global bonds were doing precisely that as of this summer. The reason? Several global central banks were buying up everything in sight, artificially inflating bond prices and driving yields into the gutter.

Now, there’s growing concern that the European Central Bank, the Bank of Japan, and other central banks might dial back their purchases. And here in the U.S., the Federal Reserve is talking about raising rates again – the first such move since their initial hike in December 2015.

  1. Concern the bond bubble is bursting no matter what – In early 2000, the madness in dot-bomb stocks couldn’t get any worse, and the bubble began to burst. In 2006, the madness in housing couldn’t get any worse, and that bubble began to burst.

 bubblepoppingNow, in 2016, the same thing looks to be happening in bonds. Investors are selling because they don’t want to get crushed by yet another bursting asset bubble, not because of any traditional, fundamental reason (like rising inflation, accelerating economic growth, etc.)

Regardless of the cause for falling bond prices (and the higher rates that result), the effects are widespread. Rising long-term interest rates make mortgages more expensive. That, in turn, slows home purchase activity and makes it tougher for homeowners to refinance to cut their monthly bills. Result: Less consumer spending.

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Higher long-term rates make higher-yielding stocks less attractive, leading to sell offs in sectors like utilities and Real Estate Investment Trusts (REITs). They also put pressure on the value of underlying real estate, a major problem today given how wildly overvalued commercial real estate prices are.

bonds-lrgMy advice? If you’ve made a lot of money in commercial real estate or housing investments, now is a good time to take some of your profits off the table. Cut back on investments in rate-sensitive stock market sectors like REITs, as well as longer-term bonds, ETFs, and mutual funds.

Also stay away from retailers, restaurants, home builders, and construction stocks. Companies in those sectors are going to struggle as mortgage money gets more expensive and consumer budgets get squeezed. Lastly, raise your portfolio’s cash allocation until the bond-fire cools off.

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Until next time,

Mike Larson

Mike Larson is a Senior Analyst for Weiss Research, and is also the creator of the course “How to Profit From Rising Interest Rates”. A graduate of Boston University, Mike Larson formerly worked at Bankrate.com and Bloomberg News, and is regularly featured on CNBC, CNN, Fox Business News and Bloomberg Television as well as many national radio programs. Due to the astonishing accuracy of his forecasts and warnings, Mike Larson is often quoted by the Washington Post, Chicago Tribune, Associated Press, Reuters, CNNMoney and many others.

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