By Justin Spittler
The world’s biggest financial bubble just popped.
Regular readers know we’re talking about the bond market. This is where companies and the government borrow money. It’s about twice as big as the stock market.
In other words, it’s a key pillar of the global financial system. And it’s starting to give way…
Last summer, bond yields started skyrocketing.
The yield on U.S. 10-year Treasurys is now twice as high as it was last July.
This might sound like a good thing. After all, who doesn’t like earning more income?
But you have to realize something… Bond yields rise when bond prices fall.
• Investors aren’t used to seeing this…
After all, bonds have been rising since the 1980s. This historic bull market has survived three recessions, the dot-com crash, and the 2008–2009 financial crisis.
But Bill Gross thinks the good times are over.
Gross is one of the world’s most respected investors. He founded PIMCO, one of the world’s biggest bond fund managers. Today, he manages a giant bond fund at Janus Capital Group.
In short, he knows the bond market better than just about anyone on the planet.
In January, Gross wrote that the bond bull market would end when the yield on the 10-year Treasury topped a key level:
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 [sic] the Dollar/Euro parity at 1.00.
Since Gross issued this warning, I’ve been watching 10-year Treasurys like a hawk.
On Monday, it finally happened. The 10-year hit 2.62%.
According to Gross, the bond bull market is now officially over. A “secular” bear market has begun.
This means bond prices could fall for years, even decades.
• The world isn’t ready for this…
Remember, bonds have basically gone straight up for the last four decades.
When an asset does this, investors lose touch with reality. They buy more of that asset than they should. They assume nothing could go wrong.
But just about everything is going wrong in the bond market these days. I’ll explain why in a second. But first, we need to talk about yesterday’s Federal Open Market Committee (FOMC) meeting.
• You probably heard that the Federal Reserve raised its key interest rate by 0.25%…
Yesterday’s rate hike was only the third since 2006.
This is a very serious matter.
You see, the Fed sets the tone for rates across the economy.
If it raises its key rate, rates across the economy should rise, too. That’s bad news for Treasury holders.
And yet, Treasurys rallied on the news.
This happened because the Fed sounded “dovish” yesterday. In other words, investors think the Fed could now raise rates more slowly than planned. That’s why so many people bought Treasurys yesterday.
Does this mean you should buy Treasurys too?
• A perfect storm has hit the bond market…
I know this might sound cliché. But consider the facts…
Inflation is rising at the fastest rate in years. Inflation measures how fast prices for everyday goods rise. A high inflation rate hurts the common man. It makes everything from rent to groceries more expensive. It also chips away at bond returns.
Trump’s policies are inflationary. You've probably heard that Trump wants to spend $1 trillion fixing up America’s roads, bridges, and sewers. This sounds great… in theory. There’s just one problem.
The U.S. government is dead broke. To “make America great again,” the Trump administration will have to sell even more Treasurys. This would put more pressure on Treasury prices.
Foreigners are pulling out of the Treasury market. Right now, China, Japan, and Saudi Arabia are selling Treasurys by the truckload. Just look at the chart below.
You can see that foreigners have become “net sellers” of Treasurys over the last two years.
This is a big deal. Foreign creditors make up nearly half of the Treasury market. If they stop buying, Treasury prices will tank.
To recap, the Treasury market is imploding. And there’s nothing the Fed can do to stop it.
Look, I know a lot of people don’t want to hear this. It's difficult news to digest.
But it’s my job at Casey Research to help you protect and grow your hard-earned money. I can only do this if I’m honest with you. That means telling people the truth…even when it hurts.
With that said, I’m not the only investment analyst who’s nervous about the bond market.
• Bill Gross thinks we’re on the verge of a “credit implosion”…
He explained why in his latest monthly Investment Outlook letter.
If you haven’t already, I highly recommend that you read it front to back. But here's what you need to know right now…
Gross says the global economy is drowning in debt:
The global economy has created more credit relative to GDP [Gross Domestic Product] than that at the beginning of 2008's disaster. In the U.S., credit of $65 trillion is roughly 350% of annual GDP and the ratio is rising. In China, the ratio has more than doubled in the past decade to nearly 300%. Since 2007, China has added $24 trillion worth of debt to its collective balance sheet.
At this point, Gross says the slightest misstep could set off another major financial crisis:
Our highly levered financial system is like a truckload of nitro glycerin on a bumpy road. One mistake can set off a credit implosion where holders of stocks, high yield bonds, and yes, subprime mortgages all rush to the bank to claim its one and only dollar in the vault.
• If you’re betting that the Fed will get us out of this mess, don’t…
The Fed painted itself into a corner. It’s damned if it raises rates and damned if it doesn’t.
If rates are too high (and credit as a % of GDP too high as well), then potential Lehman black swans can occur. On the other hand, if rates are too low (and credit as a % of GDP declines), then the system breaks down, as savers, pension funds and insurance companies become unable to earn a rate of return high enough to match and service their liabilities.
Keep in mind, the collapse of the iconic investment bank Lehman Brothers helped ignite one of history's worst financial crises. The average U.S. stock plunged 57% between 2007 and 2009. The U.S. economy entered its worst economic downturn since the Great Depression.
• The good news is that there are simple steps you can take to protect your wealth…
Here’s what we recommend.
Lighten up on bonds. Bonds aren’t the safe investment they used to be. They’re a gamble.
If you still own bonds, you’re basically risking a lot of money for the chance to make a little. Those aren’t the kind of investments we like to make.
Take a hard look at the stocks you own, too. As Gross said, a credit implosion would hit stocks as well as bonds. You can lower your risk by selling your weakest positions.
Start by getting rid of your most expensive stocks. They tend to crash the hardest during broad market declines.
You also shouldn’t own companies with too much debt. If the bond market continues to unravel, corporate borrowing costs are going to surge. This is going to create big problems for companies that need cheap credit to make money.
We’ll have more to say about this bond crisis in tomorrow’s Dispatch. Until then, stay disciplined…
Delray Beach, Florida
March 16, 2017
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