Published January 13, 2017

“Rest in Peace,” Bull Market

Investors can’t take their eyes off the Dow.

The Dow Jones Industrial Average has jumped more than 7% since Election Day. Last month, it set a new all-time high.

But that hasn’t been enough for many folks. They’re waiting for the Dow to top 20,000.

From a technical perspective, "Dow 20,000" wouldn’t mean much. Right now, it sits at 19,876—within 1% of the mark.

Still, Dow 20,000 could have a huge psychological impact. After all, it’s a big, round number. Most people would be excited to see the Dow reach this milestone. If it does happen, many investors who are sitting on the sidelines could jump back into stocks.

But that doesn’t mean you should obsess over Dow 20,000.

• Bill Gross says there’s a much more important number you should be watching…

Gross is one of the world’s most respected investors. He founded PIMCO, one of the world’s biggest money managers. Today, he manages a giant bond fund at Janus Capital Group.

According to Gross, investors should be watching the bond market, not the Dow. He wrote in his monthly investing letter earlier this week:

[T]his is my only forecast for the 10-year in 2017. If 2.60% is broken on the upside—if yields move higher than 2.60%—a secular bear bond market has begun. Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the Dollar/Euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017.

Notice Gross said “secular” bear market. That means he thinks bond prices could fall for years, possibly decades.

• Right now, the U.S. 10-year Treasury yields 2.4%…

That’s only 20 basis points (0.2%) below 2.6%.

In other words, Gross thinks the bull market in bonds could end any day now. Most investors aren’t ready for this.

You see, bonds have been in an uptrend since the 1980s. This historic bull market has survived three recessions, the dot-com crash, and the 2008–2009 financial crisis.

Many investors have only seen bond prices go up…that is, until recently.

• The bond market started unraveling last summer…

You can see in the chart below that the yield on U.S. 10-years is now almost twice as high as it was last July. (A bond’s yield rises when its price falls.)

Corporate and municipal bond yields have also skyrocketed over the last few months.

• Bond yields are surging for a few reasons…

For one, the Federal Reserve just lifted its key interest rate for only the second time since 2006. The Fed also plans to raise rates three more times in 2017.

This has had huge implications for the bond market.

You see, the Fed’s key rate sets the tone for other rates. When it rises, bond yields rise, too.

Most investors also expect economic growth and inflation to pick up under Trump, which would both be bad for bonds.

• Jeffrey Gundlach thinks the bull market in bonds is coming to an end, too…

Gundlach is another world-class investor. He manages more than $100 billion at DoubleLine Capital. Many folks consider him the new “Bond King,” a nickname Gross held for decades.

Like Gross, Gundlach thinks rates will keep climbing. But he expects the 10-year yield to blow past 2.6%. Business Insider reported yesterday:

It's "almost for sure" that the 10-year yield is going to take out 3% in 2017, Gundlach said. "It's bye-bye bull market, rest in peace." Yields rise as bond prices fall.

"That will define the end of the bond bull market from a classic chart perspective, not 2.60," he added. That's because there would no longer be declining valleys in yields, with the trough of 1.39% established in 2012.

The yield on the U.S. 10-year would have to rise another 60 basis points (0.6%) to hit 3.0%.

A year ago, that might have seemed impossible. Not anymore. Remember, the yield has already surged 100 basis points (1.0%) in just six months.

Gundlach doesn’t think the 10-year yield will stop at 3.0% either. He thinks it could reach 6% by 2020. That would be the highest level since 2000.

• You might not be worried about this if you don’t own any U.S. bonds…

But you have to keep in mind, the bond market is nearly twice as big as the stock market.

It’s also where companies borrow money. If rates keep rising, it’s going to become more expensive for companies to borrow money. And that’s the last thing Corporate America can afford right now.

Since 2010, U.S. corporations have borrowed $9.3 trillion in the bond market. That’s 57% more than they borrowed in the seven years leading up to the 2008–2009 financial crisis.

• Corporate America is now drowning in debt…

The debt-to-EBITDA ratio for non-financial companies in the S&P 500 now sits at 1.88, according to research firm FactSet. That's up from 1.0 at the start of 2015. It's also the highest level in over a decade.

If borrowing costs keep rising, companies with a lot of debt could struggle to pay their bills. We could even see a huge spike in corporate defaults.

Gundlach thinks problems in the bond market could spread to other parts of the economy, too. Barron’s reported in December:

“We’re getting to the point where further rises in Treasuries, certainly above 3%, would start to have a real impact on market liquidity in corporate bonds and junk bonds,” the DoubleLine head said, according to ThinkAdvisor.com. “Also, a 10-year Treasury above 3% in my view starts to bring into question some of the aspects of the stock market and of the housing market in particular.”

• Casey Research founder Doug Casey encourages you to “sell all your bonds”…

You should also take a good, hard look at your stock portfolio.

If you own stocks that would be hurt by higher rates, you should consider selling those positions. These include utility and telecom stocks, which are basically “bond proxies.”

You should also avoid companies that need cheap credit to make money. If rates keep rising, these companies could run into serious problems.

Chart of the Day

Investors haven’t been this complacent in years.

Today’s chart shows the performance of the Volatility Index (the "VIX") since 2010. The VIX tells us how volatile traders expect the near future to be.

When the VIX is high, it means traders expect a lot of volatility. When it’s low, it means they think the market will stay calm.

You can see that the VIX is now at its lowest level in years. In fact, it’s only been this low three other times since 2010.

This tells us that investors don’t have a care in the world right now. They’re still riding the “Trump Honeymoon.”

Now, we realize Trump could go down as the most “pro-business” U.S. president since Ronald Reagan. But it’s going to take time for him to implement his policies. Many investors seem to have forgotten this.

You also have to remember the U.S. stock market has big problems that the president could never fix. For starters, corporate debt is through the roof and U.S. stocks are incredibly expensive.

In short, investors shouldn’t be complacent right now. They should be nervous.

That's why we urge you to own physical gold. It's the best way to protect yourself from a stock market crash or any other financial crisis.

Regards,

Justin Spittler
Delray Beach, Florida
January 13, 2017

We want to hear from you.

If you have a question or comment, please send it to feedback@caseyresearch.com. We read every email that comes in, and we'll publish comments, questions, and answers that we think other readers will find useful.