Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

If You Own U.S. Bonds, This May Be the Perfect Time to Pause and Reflect

Friday, January 18th, 2013
By for Profit Confidential

The year 2012 wasn’t a bad year for the stock market, thanks to the Federal Reserve keeping interest rates near zero and the Fed increasing the money supply to a record level. But for bonds, it was a breakeven year, as U.S. bonds closed out 2012 at about the same level they started the year.

The Federal Reserve has been keeping interest rates artificially low since the financial crisis struck the U.S. economy and investors in U.S. bonds faced falling yields and the price of bonds rose. (Bond prices go up when interest rates go down and vice-versa). Real returns on bonds are actually negative when one considers inflation.

Here’s a chart of the 30-year U.S. Treasury:

$TYX 30-Year T-Bond Yield Stock market chart

Chart courtesy of www.StockCharts.com

At the beginning of 2011, the yield on 30-year U.S. bonds went as high as 4.8 %. Now the same bonds yield is just a little above 3.0%. The 30-year U.S. bonds fell to as low as 2.4% in April of 2012.

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Here’s the 10-year U.S. Treasury chart:

$TNX 10 year treasury note yield stock market chart

Chart courtesy of www.StockCharts.com

Same story; since the beginning of 2011, the yield on 10-year bonds has fallen more than 50%, to as low as 1.4% in April of 2012.

The big concern is that the longer the Federal Reserve keeps interest rates low, the more the chances of inflationary pressures. As inflation rises, investors in U.S. bonds get a lower real rate of return. In fact, investors in U.S. bonds might even be faced with negative returns after adjusting for inflation. Add to this the fact that the never-ending spending of our government could be destroying the credibility of U.S. bonds, and you have trouble.

Currently, the U.S. government has debt of more than $16.4 trillion (see the debt clock at www.investmentcontrarians.com) and, by no surprise, it continues to rise. Unfortunately, it doesn’t stop here; the Congressional Budget Office (CBO) estimates that, in the next 10 years, the national debt will increase to $20.0 trillion. (Source: Wall Street Journal, January 2, 2013.)

Credit rating agencies are already being cautious. Both Moody’s Investor Services and Standards & Poor’s (S&P) advised that the U.S. government has to take more measures to reduce its annual budget deficit (increase revenue or cut spending). The efforts to ward off the effects of the infamous “fiscal cliff” were not enough. Yesterday, Fitch Ratings said that if the U.S. doesn’t raise its debt ceiling by the end of February, its credit rating could be cut again. (Source: Toronto Star, January 15, 2013.)

If you own U.S. bonds, this seems to be a perfect time to pause and reflect.

The Federal Reserve has been keeping the interest rates low and inflationary pressures are building up fairly quickly—look at the food prices, oil, and other commodities. I believe the U.S. economy will weaken in 2013 and the Fed will have no choice but to keep the money taps open. This will push down the yield on U.S. bonds further, which is good for bonds.

But once interest rates start to move higher in the wake of rising inflation and too many dollars in circulation, interest rates could move up very quickly, causing a sudden fall in bond prices. As they say, “Investor Beware!”

What He Said:

“Despite all my ‘yelling’ and ‘screaming’ about gold, I believe only a few of my readers and a small fraction of the general public haven taken a position in gold. Why? Because gold’s not trendy…buying condominiums for investment is! If you are an investor, you need to seriously look at investing in gold stocks, because gold bullion prices will likely continue to rise.” Michael Lombardi in Profit Confidential, September, 21, 2005. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.

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Michael Lombardi - Economist, Financial AdvisorMichael bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely, reading every book he could find on the topic and taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Some of the stock recommendations in Michael's various financial newsletters have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management. Michael became an active investor in real estate, art, precious metals and various businesses. Readers of the daily Profit Confidential e-letter are offered the benefit of the expertise Michael has gained in these sectors. Michael believes in successful stock picking as an important wealth accumulation tool. Married with two children, Michael received his Chartered Financial Planner designation from the Financial Planners Standards Council of Canada and his MBA from the Graduate Business School, Heriot-Watt University, Edinburgh, Scotland. Follow Michael and the latest from Profit Confidential on Twitter or Add Michael Lombardi to your Google+ circles