Bond Market Shows Signs of Weakness Ahead

Something is starting to smell in the bond market

Since their peak in July of 2012, 30-year U.S. bonds have declined in value—they are down almost six percent. Trading above $153.00 in mid-2012, 30-year U.S. bonds now hover around $144.00, as depicted in the chart below.

Bond Market Shows Signs of Weakness Ahead image USB 30 Year US Treasury Bond Price stock chart1$USB 30 Year US Treasury Bond Price stock chart

Chart courtesy of www.StockCharts.com

Keep in mind that bond investors use U.S. bonds as a benchmark to what kinds of rates other types of bonds, such as corporate bonds, municipal bonds, and junk bonds, should sell at.

For example, if U.S. bonds decline in value, chances are the other types of bonds in the bond market will follow in the same direction. So the yield on 30-year U.S. bonds really matters when it comes to looking at the direction of the overall bond market.

The bond market experienced a significant run-up as the 2008 financial crisis unfolded and investors sought safety. Now, investors have a different type of worry on their hands.

The Federal Reserve, which has become a major buyer of long-term U.S. bonds, buying up to $45.0 billion worth of them a month, is contemplating when it should stop reducing the amount of bonds it purchases each month.

According to data from Investment Company Institute, an association of U.S. investment companies, in the first three months of 2013, long-term bond mutual funds had inflows of $68.9 billion. This was 25% lower than the same period a year ago, when these funds had inflows of $92.08 billion. (Source: Investment Company Institute, May 8, 2013.)

As I have been harping on about in these pages for some time now, caution and capital preservation are hands-down the best strategy for bond investors, as conditions in the overall bond market are changing. A decline in the bond market will hit the most conservative type of investments, like pension funds and insurance companies, which invest heavily in bonds.

I am watching the bond market very closely as the recent decline in bond prices is significant. Bonds are signaling higher interest rates ahead, something very few economists are talking about.

Where the Market Stands; Where It’s Headed:

As I wrote last week, it feels like 2007 all over again. The stock market rises on good news and bad news. Bullishness among investors and stock advisors is near a multiyear high. Corporate profit growth has stalled. The higher this market goes, and it has gone higher than even I thought it would, the bigger the drop will be. The bear market has done a masterful job at convincing investors the stock market is a safe bet again.

What He Said:

“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure – these are the bank stocks I wouldn’t own.” Michael Lombardi in Profit Confidential, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.

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