Could the unthinkable be happening in the U.S. bond market?

Yesterday, the U.S. Treasury Department sold just over $30.0 billion in three-year treasury notes and it wasn’t seeing the action it’s used to seeing.

There is usually more demand for treasuries than what the government offers. But, yesterday, demand was only 2.9 times the amount of treasuries offered, which was below the approximate usually demand of about 3.2 times. So rates moved higher on bonds.

And, boy, did they move higher. The bellwether U.S. 10-year note started out yesterday morning at a yield of 3.03%. It ended the day at about 3.16%. Quietly, the yield on U.S. 10-year treasuries has risen from 2.6% at the beginning of November to 3.16% yesterday, a gain of 21% in less than 40 days. This means (as I have been warning for months) that the bond market and bond investors are getting hammered.

The yield on the 10-year Treasury is now at its highest level since June of this year. If the point behind the Fed’s Quantitative Easing Part II measure was to lower long-term yields, I don’t see it working.

I’ve written extensively on these pages about how my biggest fear for 2011 is higher interest rates. Rising rates will be damaging for the economy and the stock market. With the stock market being a leading indicator, maybe, just maybe, this year’s gain of only 8.9% on the Dow Jones is an indication that interest rates will be a problem in 2011.

My opinion remains unchanged: For the remainder of 2010, I’m looking for strong markets. Looking into 2011, I start to get cautious.

Michael’s Personal Notes:

Rarely, rarely, do I comment on people outside the financial world, but I was overwhelmed last night to hear that Elizabeth Edwards had passed away. Elizabeth was separated from former U.S. Senator John Edwards.

Ms. Edwards fought cancer during two of her husband’s failed runs for high political office (first for President, then for Vice President), lost a teenage son to an automobile crash, and dealt with her husband’s high-profile infidelity. She is survived by two young children, a daughter of 12 and a son of 10.

Why do I mention all this? Because it is at times like these when you realize how fragile life can be. Elizabeth Edwards passed away at the ripe age of 61. She probably endured more tragedy than most of us will in life. But no matter how difficult things got for her, she plowed ahead and persevered. And, to me, that is what life is about: never giving up. If you have a chance, you should look at her 2009 book, Resilience, published by Crown Archetype. It truly is a reflection on the burdens and gifts of facing life’s adversities.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this morning up 8.9% for 2010. Yesterday, the Dow Jones came within a single point of crossing over the index’s 52-week high.

Actually, if the Dow Jones were to pass its 52-week high of 11,451, it would be at its highest level since September 2008. Comparatively, if we look at the economy, doesn’t it feel like the economy is at about its best level, strength wise, since September 2008?

This morning, The Home Depot, Inc. (NYSE/HD) announced that it expects sales for 2011 to rise by only 2.5%, while profits are expected to rise about 10%. This scenario is common with many big companies these days: They are seeing marginal top-line revenue, while profits run higher, as expenses (often labor) have been trimmed over the past few years. I expect to see more Home Depot “type” projections for 2011. I also believe many companies are forecasting conservatively these days…they’d rather surprise the market on the upside than on the downside.

While I read a few analyst reports yesterday, basically saying “I told you so, the market cannot break to new highs,” my view is opposite this. I expect the Dow Jones to break to news highs as the bear market rally that started in March 2009 continues. (The S&P 500 did close at a new 26-month high Tuesday.)

What He Said:

“Homebuilding in the U.S. will enter a quasi depression state in 2008 and the construction industry will make 2008 a record year for pink slips. I predict that a major homebuilder will go bankrupt in 2008.” Michael Lombardi in PROFIT CONFIDENTIAL, January 10, 2008. WCI Communities, the largest U.S. luxury homebuilder, filed for Chapter 11 protection on August 4, 2008.

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