Worst Investment You Can Make in 2011

Why bonds are a bad investment right now.In each PROFIT CONFIDENTIAL editorial, we quote an older edition of this e-letter, usually an exact prediction I made and the forthcoming outcome. You’ll find this daily in a section below entitled, “What He Said.”

Today’s “What He Said” paragraph is a quote from the summer of 2006, when I said that bonds were a buy. That prediction was quite timely. By the time the financial crisis hit in 2008, interest rates fell to zero and bonds enjoyed some of their best returns in history, from the summer of 2006 to the summer of 2008.

But today, in 2011, I feel totally the opposite about bonds. I think they are a terrible investment. In fact, I don’t personally own any bonds. Today, the 10-year U.S. Treasury yields 3.33%. In early October of 2010, that same 10-year U.S. Treasury was yielding 2.4%. Bond investors who bought at any time since June 2010 would face large losses on their bonds if they sold today.

If I’m right about my prediction on the future of the U.S. dollar, given the fast-paced debt accumulation of our government, interest rates will need to rise in order to attract foreigners to purchase the U.S. Treasuries we so desperately need to sell to fund the government.

If I’m right about inflation and it starts to rise unexpectedly in light of all the financial liquidity in the market place, interest rates will rise to fend off inflation.

If I’m wrong about the stock market, and in the short term to long term it continues to rise, interest rates will rise in an effort to prevent another stock market bubble.

Finally, if I’m wrong about the U.S. economy and Gross Domestic Product (GDP) starts to rise three percent to five percent per annum again, interest rates will rise to cool the economy.

Any way you look at it, interest rates, in my humble opinion, will rise more aggressively than analyst are currently predicting. And that is what makes bonds such a bad investment right now.

If we look at the stock market, the Dow Jones Industrial Average is at its highest level since June 2008. But back then, the 10-year U.S. Treasury was yielding over five percent. Based on the charts, U.S. Treasuries are well known for lagging the direction of the stock market. In other words, the prices of bonds, which are based on their yields, closely follow the direction of the stock market: up or down.

Finally, higher interest rates are not just a negative for the bond market; they are a big drag on the U.S. housing market. The more rates rise, the smaller the pool of qualified buyers for homes. And maybe that’s just what the Dow Jones U.S. Home Construction Index has been telling us—it’s still down close to 70% since 2006.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average has enjoyed a tremendous January thus far, up 209 points or 1.8% on the year.

As I have been writing since late December, I expect the stock market to continue rising in the immediate term, as the bear market rally that started in March 2009 gives its final “blow off.” The Dow Jones Industrials at 12,000 is a strong possibility.

However, and as per my lead article today, rising interest rates will cap the growth of the stock market sooner rather than later. I’m turning bearish on stocks in the short to long term for a variety of reasons that I regularly write about in PROFIT CONFIDENTIAL.

To my dear readers: enjoy the stock market gains while they last!

What He Said:

“Bonds could now be a buy: Bonds rise in price when interest rates fall, as their return makes them more valuable. After a bear market in bonds that has lasted for months, the action in the bond market, as I read it, indicates that the bear market in bonds could be over. I’ve always preferred quality when buying bonds, going with government bonds over corporate bonds. If you have some cash lying around, bonds could be a great deal.” Michael Lombardi in PROFIT CONFIDENTIAL, July 24, 2006. Government bonds were one of the best performing investments from mid-2006 to late 2008, as they rose in price sharply when the Fed reduced interest rates back to one percent in October 2008.