Read it Here First: Why Interest Rates Are Headed Up

by Michael Lombardi, CFP

I know that people will think I am off my rocker again, but in respect to the economy, I’m worried about something no else is talking about.

Every once in a while, my contrarian way of thinking puts me on a different path. For example, I was telling people to get into gold in 2002, when there was absolutely no interest in gold as an investment. I told people to get out of real estate in 2005, when everyone was getting into real estate. I turned bearish on the stock market in 2007 (which turned out to be another great call).

The purpose here is not to pat myself on the back. In fact, I have deep humility. The purpose is to show you how going against the trend and the exact point that 95% to 99% of investors and analysts are against you often pays off. Going back to my major concern, which I don’t read anywhere else — and that concern is higher interest rates ahead.

Yes, I know the U.S. Federal Reserve said that it would keep interest rates at zero for a long time. And I know the Bank of Canada said that it would keep interest rates low for the next 14 months. But here is how I see it unfolding:

The bear market rally in stocks we are now seeing will move stocks to the “profit zone” for 2009 (I’ve been predicting this for months). People will get back into the stock market. It will seem as if the worst for the economy is over. Interest rates will then rise, sending the bear market back to test the market lows the bear reached on March 9, 2009.

How do I know interest rates will rise? Two reasons.

First, the bond market has been declining sharply since mid-January. Bonds work this way: If interest rates fall, bond prices rise. If interest rates rise, bonds fall. We have a situation now where interest rates have fallen, but 30-year T-bills have been falling. Why? Because the bond market is predicting higher interest rates ahead.

Second, the U.S. dollar has been falling since mid-March. The Canadian dollar is up sharply, gold is rising, and the U.S. dollar is falling. At some point ahead, the U.S. will need to raise interest rates to support the dollar; otherwise, good luck selling our ever increasing debt obligations to foreign investors. This second point is likely the worst-kept secret amongst gold bugs.

So there you have it. My big concern is higher interest rates ahead, especially the fact that it will take the great majority of people by surprise and the negative impact higher rates will have on the economy.

Michael’s Personal Notes:

At a business dinner meeting last night, there were four of us all representing our various businesses. These businesses range in size from 200 employees at the small end to 5,000 employees at the large end. Invariably, the conversation at the table turns to the current economic situation. In all cases, the four businesses met or even bettered their profit forecasts for the first quarter of 2009. And, in all cases, these businesses made drastic cuts to expenses to meet first-quarter numbers. Why am I telling you this? As I have been writing in this column for three years now, the excess fat companies put on in the mid 2000s as they expanded is being cut, making businesses more efficient and profitable, but resulting in major job losses for consumers. Most recessions end with consumers spending their way out of recession. How can that happen with the unemployment rate headed to 10%?

Where the Market Stands:

Predicting the stock market would regain all of its losses for 2009 in this current bear market rally is proving to be one of my best calls of the year. The march to higher stock prices has continued relentlessly, with the Dow Jones Industrial Average up eight out of the last nine weeks. For the year, the Dow is down a shrinking three percent. The NASDAQ and the S&P 500 are all up for the year. There will be a major celebration of “good times are back” in the media when the Dow Jones turns positive for the year. Don’t be fooled. It’s just a bear market rally sucking investors back into stocks.

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 fell 65%.