Not too long ago, the European Central Bank (ECB), to fight the economic slowdown in the eurozone, lowered its benchmark interest rates. The hope with this move was the same as it was in the U.S., England, Japan, or other countries that are facing economic scrutiny: lowering interest rates will eventually increase lending and eventually bring in economic growth. In addition to this, the ECB also announced that it will be taking part in an asset purchase program—something similar to what was implemented by the Federal Reserve.
When I look at all this, it creates a very interesting situation. The ECB is lowering its interest rates as the Federal Reserve and others, like the Bank of England, are building grounds to raise their benchmark interest rates.
For example, the Bank of England is hinting at raising interest rates by spring of 2015. The governor of the central bank, Mark Carney, recently said that if interest rates were to rise in the spring as the markets expect, this move would allow the bank to meet its mandate regarding inflation and jobs creation, according to its forecasts. Simply put, the bank is prepared to raise interest rates early next year. (Source: Hannon, P., “Bank of England Gov. Mark Carney Signals Spring Rate Rise,” The Wall Street Journal web site, September 9, 2014.)
And the Federal Reserve may do the very same.
With this in mind, I question where the next big trade is going to be.
Remember what happened during the financial crisis, when the Federal Reserve and other central banks lowered their interest rates? In search of yields, the easy money … Read More
The verdict is in…
The Federal Reserve will taper further. In its statement, the Federal Reserve said, “Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month.” (Source: Board of Governors of the Federal Reserve System web site, March 19, 2014.) The Federal Reserve has been tapering quantitative easing since January by $10.0 billion each month, coming down from $85.0 billion a month in December.
To us, it will not to be a surprise to see the Federal Reserve taper further. If this becomes the case, then in just five months, there will be no quantitative easing. The printing presses will stop.
This doesn’t bother me. It’s all too known and expected.
With this taper announcement, the central bank also provided its projections on where the federal funds rate—the rate at which the Federal Reserve lends to the banks—will go. It said the rate can increase to one percent by 2015. By 2016, this rate can go up to two percent. Mind you, the federal funds rate has been sitting at 0.25% for some time now—since the U.S. economy was in the midst of the financial crisis.
What happens next?
Economics 101 tells us that when interest rates increase, bond prices decline and bond yields increase.
Quantitative easing and low interest rates have caused more harm than good. These two phenomena caused the bond prices to rise and … Read More
There’s uncertainty on the stock market. Troubles are coming from the emerging markets, and they are causing investors to panic and sell their stocks. We see they are scared. But as this is happening, there’s a trade in the making, and those investors who have raised some cash (as I’ve been suggesting my readers do) and are looking to park their money somewhere safer than stocks can profit from this opportunity.
The trade I’m talking about is the trade that’s happening in U.S. bonds and gold bullion—some call this phenomenon a “flight to safety.” I call it a potential opportunity.
We know bonds and gold bullion are one of those asset classes where investors rush to when the risks on the stock market increase. This is something we are seeing now, and it could continue for some time.
In the following chart, I have plotted the prices of U.S. bonds (red line), gold bullion (black line), and the S&P 500 (green line). Take a look at the circled area, which shows the movement out of stocks.
Chart courtesy of www.StockCharts.com
Since the beginning of the year, U.S. bonds and gold bullion prices have increased in value, while the stocks have fallen. We have seen this relationship before as well. A prime example of this is the stock market sell-off in 2009; we saw investors rush to gold bullion and bonds then in hopes of finding safety.
It’s not too late for investors to consider taking advantage of this shift by looking at exchange-traded funds (ETFs), like iShares 20+ Year Treasury Bond (NYSEArca/TLT). Through this ETF, investors can invest in long-term … Read More
Generally speaking, investors move their money from risky assets, such as stocks, to less risky assets, like bonds and cash, when they feel uncertainty is increasing. One of the most recent and great examples of this was the 2008–2009 sell-off in the stock market. Investors ran to the bond market, driving bond prices higher and yields lower. Their reasoning was that the stock market could see a further decline—and it did. On top of that, the Federal Reserve started to buy bonds, so investors had more incentive to stay in the bond market.
In 2013, we saw investors rush to the stock market, and we also heard that the Federal Reserve will be reducing its bond purchases. This created pressures on the bond market, and bond prices declined very quickly. The notion this time was very simple: why stay with low yields when you can get a higher return on your investments in the stock market, especially since the Federal Reserve isn’t buying as much.
Since entering 2014, something interesting has been happening. We are seeing investors rushing to the bond market, and the stock market is seeing a decline. Below, you can see the chart that shows this relationship. I have plotted yields of 30-year U.S. bonds as an indicator of the bond market and the S&P 500 as an indicator of the stock market. Pay close attention to the circled area.
Chart courtesy of www.StockCharts.com
Note that when we see buying in the bond market, yields decline. This is the phenomenon we have seen occurring since the beginning of 2014.
The chart above suggests that investors are leaning … Read More
The Federal Reserve has been very accommodative. Its goals are very simple: it wants economic growth in the U.S. economy. As a result, the Federal Reserve is taking extraordinary measures, printing $85.0 billion a month and using it to buy U.S. bonds and mortgage-backed securities (MBS). The hope is that the money will go to the banks, which will lend it to consumers who then spend it, leading to economic growth.
Sadly, the problems continue to persist in the U.S. economy, leaving economic growth still far from sight. The techniques used by the Federal Reserve aren’t working: the unemployment rate continues to be staggeringly high, troubling trends have formed, and the inflation continues to be low—threats of deflation loom.
Given all this, one would assume there might be something else that the Federal Reserve can do. Unfortunately, instead of using different measures to fight the problems in the U.S. economy, the Federal Reserve is planning to keep on doing what it has been doing for years now. I believe the techniques used by the Fed will continue on for some time.
Here’s my reasoning: in a testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, the newly nominated chairman of the Federal Reserve, Janet Yellen, said, “We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been … Read More
The stock market is certainly getting all the attention these days, but not a lot is said about other disturbing fundamentals. These fundamentals are troublesome, and if they aren’t fixed, the U.S. economy could end up in a downward spiral in a very short period of time. With these conditions, those who are saving and investing for the long term can face a significant amount of scrutiny.
I’m talking about the U.S. national debt and the U.S. government posting another budget deficit.
When someone goes to get a loan, the bank usually asks how much in assets the person has or what their credit score is; this way, the bank can judge their ability to pay back the loan. If a person has a significant amount of debt already and a bad credit score, then banks will be hesitant to give them anything. There’s no rocket science behind this; the chances of a person with bad credit and a lot of debt defaulting on their liabilities are very high.
When I look at the U.S. economy, I see something very similar and wonder if those who are buying U.S. bonds, thereby giving loans to the U.S. economy, will one day say, “No, we will not give you any money.”
You see, since the financial crisis, the U.S. government has been registering a massive budget deficit. For example, in fiscal 2012, the U.S. government posted a budget deficit of over $1.0 trillion. In fiscal 2013, the U.S. government registered a budget deficit of $680 billion—slightly lower than the preceding years, but a deficit nonetheless. (Source: “Final Monthly Treasury Statement of Receipts … Read More
The financial crisis struck the U.S. economy five years ago. Those who remember the collapse of Lehman Brothers know how much uncertainty was actually there. It seemed the U.S. economy was going to halt and the financial system would collapse. Ripples across the global economy were felt. Nothing looked safe—it was a total bloodbath. Investors had many questions, including if they would be able to protect their nest eggs.
As a result of all this, to fight the uncertainty and handle the issues at hand, the U.S. government and the central bank jumped in and started to spend. They bailed out the big banks in the U.S. economy to make sure everything would continue to run smoothly. We passed through that successfully, and the worst didn’t come upon us.
Sadly, as all this happened, we saw troubling trends starting to form in the U.S. economy.
Look at the national debt.
As the government started to rev up its spending spree, it posted a budget deficit and eventually borrowed money. To give you some idea, in January of 2008, when the behemoth was starting to awaken, the national debt of the U.S. economy stood at $9.2 trillion. Fast-forwarding to now, it stands at $16.7 trillion. Simple math suggests this is an increase of more than 81%. (Source: “The Daily History of the Debt Results,” Treasury Direct web site, last accessed September 20, 2013.)
Unfortunately, it doesn’t end here. Not too long ago, Treasury secretary Jack Lew sent a letter to the U.S. government saying that if they don’t increase the national debt limit currently in place by October, the U.S. economy … Read More
Will the Federal Reserve taper quantitative easing in September? This question has become the main topic of discussion among investors, since reducing or ending quantitative easing can have significant implications on the broader market. By the way, the Federal Open Market Committee (FOMC) meets on September 17 and 18. (Source: “Meeting calendars, statements, and minutes (2008-2014),” Federal Reserve web site, last accessed September 9, 2013.)
It’s no surprise that there is speculation. We are hearing some say the Federal Reserve will start to slow its purchases, and others are saying it won’t. It’s all becoming very confusing, to say the least.
Investors who are looking to invest for the long term need to first evaluate the situation by looking at what we know.
Last year, when the Federal Reserve started buying $85.0 billion worth of mortgage-backed securities (MBS) and government bonds, it said it would continue this operation until the unemployment rate hit 6.5% and the inflation outlook was 2.5%. (Source: “Press Release,” Federal Reserve web site, December 12, 2012.)
Where do we stand on unemployment and inflation?
Unemployment in the U.S. economy has certainly improved—if you look at the numbers on the surface, at least. In August, the jobs market report found that the unemployment rate in the U.S. economy was 7.3%, slightly lower from July, when it was 7.4%. Sadly, this is nowhere close to the Federal Reserve’s target; as a matter of fact, it’s running at more than 12% from its target. (Source: “The Employment Situation — August 2013,” Bureau of Labor Statistics, September 6, 2013.)
According to the data provided by the Bureau of … Read More
Investors beware: the bond market is treading in dangerous waters. The risks are increasing, and if all the pieces of the puzzle fall into place, it can make a significant dent in your portfolio.
Look at the chart below of yields on long-term U.S. bonds. It shows the yields continuing to increase, while bond prices are falling.
Since the beginning of May, the bond market has seen a massive sell-off. Going by the chart above, yields on the 30-year U.S. bonds have increased more than 30%. This is significant and shouldn’t go unnoticed, because long-term U.S. bonds are used as a benchmark for rates on other bonds in the bond market. If the U.S. bonds decline in value, their yields increase, and the bond market usually moves in the same direction.
We are seeing that investors have started to flee the bond market already.
According to the data from Investment Company Institute, in June, the U.S. long-term bond mutual funds witnessed their first outflow since August 2011, with outflows amounting to more than $60.4 billion. In May, there were inflows of $12.2 billion. (Source: “Historical Flow Data,” Investment Company Institute web site, last accessed August 8, 2013.)
Why is this happening? The Federal Reserve, which has kept the bond yields lower by becoming a major purchaser of U.S. bonds, is contemplating when it should decrease the amount of its monthly bond purchases. There is fear that a cut in the Fed’s bond buying could further escalate the sell-off in the bond market.
On top of this, there’s a notion that the U.S. economy is getting better. Investors usually run towards … Read More
Starting near the end of 2012 and then going into 2013, there was a significant amount of noise around the concept of the “Great Rotation.”
The idea behind this concept is that low yields on U.S. bonds would cause investors to sell their bonds positions, which would eventually bring bond prices down, driving investors toward stocks. That would send the key stock indices higher.
Now, since the Federal Reserve announced that it might be pulling back on its quantitative easing, the concept of the Great Rotation seems to be gaining some traction once again. And investors are asking if it’s really going to happen.
Looking at the chart below of 10-year U.S. bond yields, it’s very clear that investors don’t like the U.S. bonds—they are selling. The yields on 10-year U.S. bonds have skyrocketed; they are now more than 44% higher than they were at their lowest level in August 2012.
Chart courtesy of www.StockCharts.com
According to TrimTabs, an investment research company, through to June 24, investors sold $61.7 billion worth of bond mutual funds and exchange-traded funds (ETFs). While this may not sound big, this is the highest sell-off since October 2008, when investors sold $41.8 billion worth of mutual funds and ETFs. (Source: Bhaktavatsalam, S.V., “U.S. Bond Funds Have Record $61.7 Billion in Redemptions,” Bloomberg, June 26, 2013.)
Now that we see investors fleeing the bonds market, shouldn’t they go to the stock market, thereby causing the markets to climb higher?
Yes, according to the concept of the Great Rotation, the key stock indices should be climbing higher. Sadly, the reality is the opposite: as the bond prices … Read More
It’s no secret: the Federal Reserve has kept U.S. bond prices higher and yields historically low by keeping interest rates low with multiple rounds of quantitative easing.
But now things have taken a minor turn, after the Federal Open Market Committee (FOMC) meeting minutes were released on June 19. “The committee currently anticipates that it will be appropriate to moderate the monthly pace of purchases later this year,” said Fed chairman Ben Bernanke. “And if the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.” (Source: “Bernanke says Fed likely to reduce bond buying this year,” Reuters, June 19, 2013.)
Simply put, the Federal Reserve will slow the pace of its current quantitative easing. With its most recent quantitative easing, the Federal Reserve is buying $45.0 billion worth of long-term U.S. bonds and $40.0 billion worth of mortgage-backed securities.
But it may end the whole program by next year, depending on the performance of the U.S. economy.
As a result of this, market participants panicked, quickly sold their positions in U.S. bonds, and ran through the exit door.
Please look at the intraday chart below of the 30-year U.S. bond yield (marked by the black and red line) and the 10-year U.S. notes yield (the green line). Pay close attention to the circled area, because this is the general area that shows what happened when the press conference was happening and the FOMC meeting minutes were released.
Chart courtesy of www.StockCharts.com
While this is … Read More
In just a matter of a few months, the S&P 500 is up more than 14%. To say the very least, these gains are nothing short of amazing—much better than what investors can get with the long-term U.S. bonds that currently yield less than 3.5%.
Consider this: on average, in the first five months of this year, the S&P 500 went up by about 2.8% per month (14% divided by five months). Assuming the stock market keeps the same pace, the S&P 500 will gain way more than 30% this year (12 times 2.8%).
Now, one must ask the question: is this sustainable? Can the S&P 500 keep going at this pace?
Since at least 1968, the S&P 500 has gone up more than 30% only three times: in 1975, when it increased by 31.55%; in 1995, when it climbed 34.11%; and in 1997, when it climbed 31.01%. (Source: “History of The S&P 500 Index,” The Standard, last accessed June 11, 2013.) Even with a massive turnaround in the stock market in 2009, the S&P 500 only increased return to 28.04%. (Source: “SPDR S&P 500,” Morning Star, last accessed June 11, 2013.)
Just looking at the economic performance of the U.S. economy when the S&P 500 increased more than 30% in the past, it was exuberant. For example, between 1975 and 1976, the gross domestic product of the U.S. economy grew 5.3%. (Source: “Real Gross Domestic Product, 1 Decimal,” Federal Reserve Bank of St. Louis web site, last accessed June 11, 2013.)
Looking at the economic conditions now, they are not as great. The International Monetary Fund (IMF) expects the … Read More
The recent decline in U.S. bond prices and the increase in yields have gotten a significant amount of attention. Some are saying the bond market is going to see a severe downturn ahead, while others are calling it a buying opportunity. Should investors jump in and short the bonds? Or should they buy even more?
Staying away from the noise, long-term investors shouldn’t just jump to a conclusion by looking at the short-term price movement. This behavior can cause a significant amount of damage to an investor’s portfolio.
Take a look at the chart below, which shows the yield on 30-year U.S. bonds:
Chart courtesy of www.StockCharts.com
Without a doubt, the yield has increased, shooting up in just a month to 3.27% from below 2.85%. Last time the yield on 30-year U.S. bonds increased by a similar amount, it took about three months, from mid-December 2012 to March of this year.
What’s certain is that the short-term momentum is clearly headed towards selling, with investors running away from long-term U.S. bonds. Since mid-July of 2012, the 30-year U.S. bond prices have been declining and are in an apparent downtrend, making lower lows and lower highs; the price of a 30-year U.S. bond has declined from $153.00 to currently hovering close to $141.00.
According to the Investment Company Institute, long-term bond mutual funds witnessed inflows of almost $16.1 billion in March. Sadly, comparing this to the inflows of March of 2012, they were 47% lower. At that time, inflows in the long-term bond mutual funds were $30.8 billion. (Source: “Historical Flow Data,” Investment Company Institute web site, last accessed, May 30, … Read More
When the financial crisis took grip on the U.S. economy, investors fled the stock market and ran towards bonds—more specifically, high-quality U.S. government bonds. The reason behind this was very simple: they would rather invest their money in something where they knew their capital was safe than in the stock market, which was uncertain at the very best.
As a result, bond prices soared and the yields collapsed. To give you some idea: near the end of July 2012, 30-year U.S. bonds had a yield of less than 2.5%. Prior to the financial crisis, these same U.S. bonds provided investors with a yield above 4.5%.
That was the past. Now, the effects of the financial crisis are going away: the U.S. economy actually seems to be improving, the financial system is in better health, and the employment situation appears much better.
With all these changes occurring in the U.S. economy, investors are asking whether the U.S. bonds market is still a safe place to be.
According to Bill Gross, also referred to as “The Bond King” by the mainstream, the bull market in the U.S. 30-year bond probably ended on April 29. The reason: the yields reached lows and the prices peaked. (Source: Cox, P. and Leondis, A., “Gross Says Bond Bull Market Probably Ended April 29,” Bloomberg, May 10, 2013.)
Keeping this in mind, take a look at the chart below of the yields on U.S. 30-year bonds, paying close attention to the circled area:
Chart courtesy of www.StockCharts.com
Looking at this chart through technical analysis, the yields of 30-year bonds show an interesting development. Since the beginning of … Read More
In its most recent statement, the Federal Open Market Committee (FOMC) said it will continue to print $85.0 billion a month. With this money, it will buy $45.0 billion worth of long-term government debt and $40.0 billion worth of mortgage-backed securities (MBS) each month.
How long will it continue to do this? As the statement suggests, “The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.” (Source: “FRB: Press Release–Federal Reserve issues FOMC statement–May 1, 2013,” Board of Governors of the Federal Reserve System web site, May 1, 2013.)
At the very core, what this essentially means is that there will be an increased supply of U.S. dollars. The Federal Reserve has printed a significant amount of money since the financial crisis to bring liquidity into the U.S. financial system. Its balance sheet has grown over $3.0 trillion, and as it continues to do the same for an unspecified amount of time, it will only increase. For example, even if the Federal Reserve stops printing (quantitative easing) at the end of 2013, its balance sheet will grow by $1.0 trillion regardless.
In the short run, the printing may work, the unemployment may decrease, and the inflation may stay tamed, but eventually, with what the Federal Reserve has accumulated over the years—the mortgage-backed securities and government bonds—it will have to sell them back into the bond market.
For investors in the bonds market, this may not be good news, because it poses a significant threat … Read More