Keith Fitz-Gerald: Put 100 investors in a room and most will tell you how worried they are that the still-bullish U.S. stock market is going to betray them for a third time in slightly more than a decade.
But I submit that it's the bonds that these folks are right now holding that should be the real focus of their concern – and for one very good reason: Most investors view the global bond market as a stodgy source of fixed income, when it's actually the largest, most complex and most sensitive capital market in the world today.
A High-Risk “Safe Haven”
Bondholders should understand two key facts about the market that they are relying on for income. I believe, not coincidentally, the following two facts also represent the biggest risks that bondholders currently face:
Growing Exposure
To see how this risk has escalated, let’s talk about money flows.
Since 2009, more than $1 trillion has flowed into bond mutual funds. That’s more than all the money that flowed into stock funds throughout the entire “dot-bomb” bubble of 1998-2000.
And we all remember how that ended.
If that doesn’t get your attention, perhaps this will.
According to the Investment Company Institute (ICI), the trade association for investment firms, bond funds that invest for safety, income and higher returns (translate that to mean investments in domestic government bonds, investment-grade U.S. corporate bonds, and “junk bonds“) – attracted more than $409 billion in 2009 and 2010. That’s more than bond funds investing in the three areas I just pointed out attracted in the 10 previous years put together.
Part of the increased money flows into bond funds was due to the global financial crisis and simple fears that things might get worse. But, surprisingly, greed was a major catalyst, too.
The fear factor is easy to understand because bonds are perceived as being less risky than stocks. That perception is especially true for government bonds – and, most specifically, U.S. Treasuries – the popularity of which is based on the implicit assumption that the U.S. government will not default on its obligations, or fail outright.
One prominent group of gloom-and-doomers predicted that we’d see virulent inflation once the economic recovery really got going. That would force central bankers – including the U.S. Federal Reserve – to sharply push up interest rates. The result: Bond prices would crater.
But just the opposite happened. We entered a double-dip downturn, which forced the Fed to slash rates – and to hold them there for an extended stretch that continues today – at least officially, anyway. The deeper rates declined, the higher bond prices surged. Those ingredients – with the Fed’s “no pain/all gain” philosophy serving as the fuel – ignited a bull market in bonds that PIMCO Chief Investment Officer William H. “Bill” Gross described as the most “brazen of all ponzi schemes.”
That’s all history, though. What’s important to understand is what’s ahead. And I see an entirely new scenario taking shape – one that investors need to understand and ready themselves for.
Looming Battle
The stage is set for a battle royale over U.S. President Barack Obama’s new fiscal budget plan, and badly needed austerity measures that should be part of the solution. While the exact fallout has yet to be determined, one of the most likely results is that interest rates are likely to head higher much sooner than the “experts” expect.
In fact, it’s already happening.
When the second round of quantitative easing – the so-called “QE2″ – was announced, the key justification was that this new initiative would help hold down interest rates. In fact, interest rates have actually advanced 16.73% on the benchmark 10-year U.S. Treasury note, putting it at 3.055%.
As Carl Kaufman, head of fixed-income strategy at Osterweis Capital Management, told Money magazine: “Loading up on Treasuries now is sort of like buying Internet stocks in early 1999. The game at this point is, ‘Let’s see if there’s still time to sell to the greater fool before the music stops’.”
I couldn’t agree more.
Indeed, that’s why I’m right now so concerned that somebody’s going to yank on the tail of the bond-market bull.
And the result of such an action is pretty easy to picture.
Moves to Make Now
The scenario that I’ve sketched out is going to happen … the only question is “when?”
Here’s how to make sure that you don’t get trampled.
Search for investment vehicles that meet your overall investment-plan objectives for timing, risk, income and share (of your overall portfolio). Here are three investments to consider as part of that search:
Written By Keith Fitz-Gerald From Money Morning
Keith Fitz-Gerald is the Chief Investment Strategist for Money Map Press, as well as Money Morning with over 500,000 daily readers in 30 countries. He is one of the world's leading experts on global investing, particularly when it comes to Asia's emergence as a global powerhouse. Fitz-Gerald's specialized investment research services, The Money Map Report and the New China Trader, lead the way in financial analysis and investing recommendations for the new economy. Fitz-Gerald is a former professional trade advisor and licensed CTA who advised institutions and qualified individuals on global futures trading and hedging. He is a Fellow of the Kenos Circle, a think tank based in Vienna, Austria, dedicated to the identification of economic and financial trends using the science of complexity. He's also a regular guest on Fox Business. Fitz-Gerald splits his time between the United States and Japan with his wife and two children and regularly travels the world in search of investment opportunities others don't yet see or understand.
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