If there is one investment to avoid in 2011, it will be bonds. Why? Simply because interest rates are headed higher in 2011.
No, we won’t see a spike in short-term interest rates. The Fed will not let that happen. But the Fed cannot control long-term interest rates. Case in point, the Fed’s recent QE2 program has thus far failed to bring long-term rates lower. In fact, long-term rates have moved up sharply over the past several weeks. Rising long-term rates will eventually put pressure on short-term rates to rise.
Why will interest rates rise in 2011?
Interest rate cycles are 20 to 30 years long in duration. Our generation has lived through an almost 30-year trend of interest rates moving higher. I believe we are now at the beginning of the next cycle, which is an up cycle in interest rates. Here’s why:
In 2005 and 2006, I was warning my readers about deflation. My contemporaries in this business thought I was crazy. But that’s what we got: deflation. The stock market moved lower, real estate obviously moved lower in price, oil fell, and general prices fell as consumer demand faded. Now, while my fellow economists are predicting deflation, I’m doing the opposite: warning about inflation.
There has never been, at least my lifetime, a period when monetary and fiscal policy of the government has been so expansive. The “liquidity” in the system, the money supply, has never been so high. How long will the Fed keep interest rates at zero?
In my experience studying the actions of the Fed, they either overshoot on the long-side or short-side. In other words, they are too slow to raise or reduce interest rates at the appropriate time. The stock market is booming again, consumers are spending. Why are short-term rates not rising marginally? Why hasn’t the Federal Funds Rate moved from zero to half a point?
Lastly, we cannot forget the fragile greenback. In 2010, the dollar simply got lucky, as the euro came under immense pressure due to the individual country crises of Greece, Ireland, Portugal and Spain (with Italy not far behind). At what point will foreigners want higher returns on the bonds they buy from the U.S.? That point may not be too far off.
Hence why I see interest rates rising in 2011. During periods of rising interest rates, bonds are one of the worse places to have your money, as bond prices decline as interest rates rise.
Michael’s Personal Notes:
A reader wrote yesterday to ask, “Mr. Lombardi, you say that if long-term bond yields continue to rise, there will be problems with the stock market. Do you mean gold and silver stocks will crash with all other stocks? Is it time to sell everything before the great collapse of 2011 and just short the market with ETFs?”
Firstly, I do not believe that the stock market will crash in 2011. Secondly, I believe gold bullion and gold stocks are headed much higher, hence I would not sell my gold stocks. Finally, I would not short the stock market either. The strength of a trend, once it is established, can never be underestimated.
Since the bear market hit a low on the Dow Jones Industrial Average of 6,440 on March 9, 2009, the Dow Jones has risen an unprecedented 79%. This is one strong upward movement that I would not bet against at this time, especially since the Dow Jones continues to make new post-crash highs almost daily.
Yes, interest rates are headed higher in 2011. As I predicted in my lead article today, the bond market will be the hardest hit as interest rates continue to rise in 2011. But please remember three things, dear reader:
The first is that the Fed will do everything it can to keep interest rates from rising. Rising interest rates are not good for consumers, businesses, real estate, or the unemployed. Hence, I don’t see a spike in interest rates; just a slow, gradual move higher.
Second, in periods when interest rates have risen, the stock market has also moved higher. This has happened repeatedly throughout history. It’s only when rates have risen sharply that the market has moved lower quickly.
Finally, gold stocks can continue to rise when the general stock market moves lower. Once a sector is hot (and gold is still not “hot” in the public’s eyes) it can move much higher in spite of the softness of the general stock market.
What I am saying is that, in 2011, we have to tread more carefully than we did in 2010. After the market low of March 2009, my message was simply: “Buy, buy stocks because they are cheap.” Going into 2011, we need to be cautious, because interest rates will slowly creep up and that will put pressure on the stock market. We need to be more selective with equities going into 2011.
Where the Market Stands; Where it’s Headed:
The Dow Jones Industrial Average opens this morning up 10.3% for 2010. Add in a 2.5% dividend yield and stocks have returned about 12.8% this year. Hopefully, my readers heeded my advice throughout the year and stayed in equities. As equally important, hopefully my suggestion to avoid the bond market also hit home with my readers.
The bear market rally in stocks that started in March 2009 continues.
What He Said:
“Interest rates at a 40-year low: The Fed has made borrowing as easy as possible, resulting in a huge appetite for loans and mortgages. We are nearing a debt crisis.” Michael Lombardi in PROFIT CONFIDENTIAL, April 8, 2004. “We will wish Greenspan never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi in PROFIT CONFIDENTIAL, April 27, 2004. Michael started warning long ago about the negative repercussions of Greenspan’s low-interest-rate policy (the Fed first dropped interest rates to one percent in 2004).