Why Investors Should Be Worried About the Sharp Rise in Bond Yields

Why Investors Should Be Worried About the Sharp Rise in Bond Yields image 190613 PC lombardiWhy Investors Should Be Worried About the Sharp Rise in Bond Yiel …While government data continue to show a lack of inflation in the U.S. economy, the bond market screams the opposite.

The Consumer Price Index (CPI), the most commonly quoted measure of inflation, increased only 0.1% in May after declining 0.4% in April. Since the beginning of the year, from January to May, inflation in the U.S. has edged higher by only 0.2%. (Source: Bureau of Labor Statistics, June 18, 2013.)

But the bond market says this isn’t true.

Since May, we have seen yields on U.S. bonds skyrocket. Take a look at the chart below; it shows the change in yields on 30-year U.S. bonds (indicated by the red line) and 10-year U.S. notes (marked by the blue line). Note the circled area.

Why Investors Should Be Worried About the Sharp Rise in Bond Yields image US bonds skyrocket chartWhy Investors Should Be Worried About the Sharp Rise in Bond Yields

Chart courtesy of www.StockCharts.com

In a matter of a few weeks, yields on 30-year U.S. bonds have jumped about 19% and 10-year note yields have skyrocketed almost 35%.

This is dangerous for bond investors. As the yields on bonds climb higher, their prices slide lower, bond investors face losses…and they’re fleeing the bond market.

For the week ended June 5, long-term bond mutual funds witnessed an outflow of $10.9 billion. Looking at it on a monthly basis, the long-term bond mutual funds haven’t seen an outflow since December of 2008. This month may just be the first since then. (Source: Investment Company Institute, June 12, 2013.)

Even the foreigners, who have been providing credit to the U.S. economy, seem to be running toward the exit. According to Treasury International Capital Data, in April, foreign residents were net sellers of long-term U.S. bonds. Private foreign investors accounted for net sales of $17.8 billion in U.S. bonds, and foreign official institutions’ net sales of U.S. bonds were $6.9 billion. (Source: U.S. Department of the Treasury, June 14, 2013.)

Dear reader, inflation is the biggest enemy of the bond market. When inflation increases, bond prices decline and yields soar.

Over the past four years, the yields on U.S. bonds have declined and bond prices have risen due to the Fed’s rigorous easy monetary policy. With massive amounts of money printing and interest rates being kept artificially low, inflationary pressures are now building up. Food and energy prices, which the government inflation figures ignore, are increasing. The rise in bond yields and the collapsing bond market mean inflation lies ahead.

Michael’s Personal Notes:

In just a few years following the Lehman crisis, credit in the Chinese economy has gone from $9.0 trillion to $23.0 trillion. Comparing it to the gross domestic product (GDP) of the country, credit has ballooned to 200% of GDP—it was only 40% before the U.S. subprime bubble burst.

Fitch Ratings’ senior director in Beijing, Charlene Sue, said this week, “…this is beyond anything we have ever seen before in a large economy. We don’t know how this will play out. The next six months will be crucial.” (Source: Evans-Pritchard, A., “Fitch says China credit bubble unprecedented in modern world history,” The Telegraph, June 16, 2013.)

Adding to the credit worries in China, just like the U.S. economy, consumers in the Chinese economy are shying away from spending. According to the China Association of Automobile Manufacturers, car sales in the Chinese economy in May grew at a slower pace than the previous month’s. The car sales growth rate registered at nine percent in May, compared to 13% in April. (Source: Financial Times, June 9, 2013.)

Furthermore, manufacturing in the Chinese economy has been witnessing a slowdown. Exports from the country have fallen victim to anemic demand in the global economy. Sadly, this year, as per government estimates, the Chinese economy is expected to grow at the pace of only 7.75%—much slower than China’s past double-digit growth rates.

The troubles in the Chinese economy continue to mount, but with the optimism seen in the key stock indices, investors are ignoring their implications. I can’t stress this enough: growing problems in the Chinese economy will not only hurt the global economy, but the U.S. economy and the rising key stock indices as well.

And I believe the estimates of China’s growth this year may be overly optimistic. The underlying issues in the Chinese economy can take the country down very fast. Think of it this way: the credit in the country has ballooned to a very dangerous level. If only five percent of the loans issued default, there will be significant repercussions.

At the end of the day, the slowing Chinese economy means trouble for the U.S. economy. What many may not realize is that some of the biggest companies based here in the U.S. economy do business in China—companies like Wal-Mart Stores, Inc. (NYSE/WMT), Caterpillar Inc (NYSE/CAT), and the biggest car makers in the U.S. economy, like General Motors Company (NYSE/GM) and Ford Motor Company (NYSE/F), all do a significant amount of business there.

The combination of China’s credit reaching 200% of GDP, manufacturing slowing, consumers reducing spending, and GDP growth declining rapidly could be a huge risk for American multinational companies and our stock market.

Where the Market Stands; Where It’s Headed:

It’s become a joke.

The stock market no longer trades on the fundamentals of an improving economy or rising corporate profits. We have a stock market obsessed with the actions of the Federal Reserve—will it continue to print money or will it pull back on quantitative easing?

When you have a stock market so focused on artificial factors, such as money printing, as opposed to fundamentals, like economic growth and corporate profits, the end for the market cannot be far off.

What He Said:

“Investors have been put into an unfair corner. Those who invested in stocks because they got caught in the tech boom (1999) have seen their investments gone. Now, those who have leveraged heavily to play the real estate game, because it is the place to be (2005), could see the same fate as the stock market investors. Thanks again, Mr. Greenspan.” Michael Lombardi in Profit Confidential, May 27, 2005. Michael started warning about the coming crisis in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.

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