The Next Economic Bubble To Avoid

The Bond Market Is a Bubble Ready To Burst

 

If you’re thinking about investing in fixed income securities, think again. It could be the biggest mistake you could ever make. And if you’re invested in certain types of fixed income, you need to think about getting out and investing your money elsewhere.

 

Interest rates are moving higher and devastation is being left in their wake. That will be the headline 12 months from now. We have enjoyed an unprecedented period of low rates for nearly a decade. After the market crash of 2007, the Federal Reserve did something that sowed the seeds of both an economic recovery and a future financial disaster at the same time: it began printing more and more money and continued that path for six years. And it’s still printing money. That excess printing came in the form of low rates and the purchasing of debt in the marketplace is coming to an end.

 

The devastation of the fixed income market doesn’t have to happen overnight, it just has to look like it’s happening. And that’s exactly what looks like is going to happen in a few months. Already the warning signs are out there. Mortgage rates are ticking higher. The ten-year treasure has moved up by almost 25% in yield. There are jitters in the junk bond market (debt securities issued by companies with less than stellar credit). In fact, the junk bond market in particular is the one market that will be devastated the most. Dump your junk bonds ASAP.

 

These bonds, issued by companies that have a questionable ability to pay creditors back, have seen yields fall to under 5%. Historically speaking, in a normal market, that type of yield would be associated with companies that had excellent credit. When rates tick up, these companies will be forced to pay more for money. But the existing bondholders, unfortunately, will be skewered by the falling prices of their holdings.

 

Bond yields fall when prices rise and they fall when prices of bonds go up. Right now bond prices are high and they are poised for a fall.

 

The impact will be widespread, with the fallout affecting the consumer credit market, the mortgage market, the emerging market debt and the debt of the U.S. Treasury and corporations. This is no small market – it is, in fact, much larger than the stock market. Many older investors forced to live on fixed incomes have significant holdings in bond funds that receive paltry yields along the way. Now they will suffer a hit in their principal as well as their paltry yields. It’s a position you don’t want to find yourself in…and if you don’t act swiftly, you could be in that position in just a few months.

 

Considering the paltry yields you are getting today, you are much better off pulling your funds and either sitting on the sidelines for a year or so and reinvesting into equity securities of dividend paying stocks that are increasing their dividends and which may also provide the opportunity for capital appreciation.

 

The bond market is in a bubble and has been for a decade. Unfortunately, most people don’t recognize a bubble until after it has burst and they have lost money. If you need any evidence, just look back at the stock market bubbles of the last couple of decades and the huge housing bubble of 2003-2007. The evidence is overwhelming that the individual investor can’t figure out when to get out. Getting out early, which is what you have to do in a bubble, is difficult to do. It takes discipline, and the ability to recognize and heed the warning signs.

 

Over the past few weeks, those warning signs have been flashing red – treasury yields rising, municipal bond yields rising, and mortgage rates rising.

 

Look at it another way: if you get out now or just pare back your holdings, what is the worst that can happen? Yields are already near historic lows anyway and if you needed to get in or wanted to get back into bonds it’s not as if you would be getting much worse yields than you are getting already. If we’re right, however, and interest rates begin to move higher as a consequence of economic growth and the Fed tightening, you will not only save your principal from loss, but you will also have the opportunity to reinvest at higher rates. Talk about a win-win situation!

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