The main appeal of bonds is that they are safe. If the stock market were a jackrabbit, full of excitement and profit potential, bonds would be your steadfast turtle, slow, reliable, and safe. Financial advisers tell us to have a greater ratio of bonds to stocks as we get older; under normal conditions this is usually true, bonds are less risky than stocks, but unfortunately conditions will be anything but normal, as inflation and interest rates rise in the lead up to and during the aftershock,this steadfast turtle will become investment road kill. Conventional wisdom says stick with bonds; they were good to us before, they will remain good to us in the future.; Aftershock wisdom states some bonds may be O.K. to invest in for now, but keep your eyes open as the investment environment begins to evolve. do not fool yourself into thinking that bonds will provide you with lasting safety.
A bond is basically a loan. There are several types of bonds:
– United States Treasury, Municipal bonds, Corporate bonds, Mortgage-backed bonds, Saving bonds, Certificates of deposit, Money market funds, and Floating rate notes. Since the 1980’s the bond bull due to falling interest rates has continued to this day and will likely continue for a while longer in the future. Since the 1980’s the amount of outstanding debt has exploded, this is not just government debt but all debt, including corporate mortgage, and government debt. When the bubble economy pops, this massive debt will be absolutely explosive.
Why conventional wisdom on bonds is wrong.
Conventional wisdom on bonds is wrong because it relies on two key assumptions: 1) the recent past is a good way to trust the near future. 2) If all else fails, the federal government will somehow save us.
First wrong assumption: The recent past is a good reason to trust the near future. The future is not the past! it never was and never will be. Right now interest rates are ridiculously low; is it reasonable from here to expect interest rates to fall even lower? As a general rule interest rates tend to run above two to three percent above the inflation rate. with current interest rates so atypically low and even negative, the odds are that interest rates will eventually rise or not fall much in the future. Right now massive money printing cannot go on forever..Why…because massive money printing eventually causes massive inflation. You simply cannot print money without avoiding devaluing the dollar. Therefore massive money printing will cause rising inflation and interest rates, creating a massive downside for bonds.
Second wrong assumption: If all else fails the federal Government will somehow save us. This will certainly be true up to the point that it is no longer true. Certainly the federal government will do all it can to protect the bond holders. As we approach the coming Aftershock, the government will not be able to save the bond market …Why? Because bonds will not be defaulted on in the next couple of years, but bonds can still loose a lot of value when inflation goes up forcing interest rates to rise.
To support the falling economy since the real estate bubble popped and the stock market crashed in late 2008, the government has been employing two powerful types of temporary stimuli: huge deficit spending (borrowing money) and massive money printing (which makes huge borrowing possible by keeping interest rates low). This has worked over the short term; without these two types of stimulus, the stock market would have crashed by now. However this stimulus itself will soon add to, not cure this problem. This is because huge deficit spending, while a temporary boost to the economy, adds to our already huge government debt bubble; and the massive money printing , while a temporary boost to the stock market will create rising future inflation. And when inflation rises significantly, interest rates will rise. Also the value of the dollar will fall- and so will the value of most dollar denominated assets, as investors make a mad dash to get out of them.
Why Aren’t Bond Investors Worried About This Now
Investors have some comforting reasons for not being too concerned about bonds yet. Recent history has been good for bonds, this is hard to ignore, especially when you want that recent history to continue, it is just natural to want things to go on forever; that’s human nature, however we often quietly know more than we actually want to face…most bond investors know that quantitative QE causes inflation, that rising inflation causes rising interest rates, and that rising interest rates causes bonds to fall. Denial is what will keep the party going in the stock market and the bond market right up until the moment that denial suddenly evaporates and everyone wants out. That is how you know it is denial.
Bonds Will Fall In three Stages
The bond market will not fall all at once, but will decline in stages leading up to the Aftershock, before the biggest crash.
Sage 1: The Recent Past and now. During the 2008 global financial crisis, while the stock market was falling about 40 percent, the bonds were unfazed, thus investors view bonds as a safe haven. Lots of things can sell temporarily sell at the wrong price until investors figure it out, at that point investors views change very quickly.
Stage 2: The Short Term Future. As long as the Unites States is viewed as the safe haven, and as long as massive money printing by the Federal Reserve keeps working to keep interest rates low, bonds will do OK, but bonds will be increasingly vulnerable over time. it is more likely that interest rates will rise, not fall, over time, and remember, any rise in interest rates will have a negative impact on bond prices. Temporarily though investors will temporarily move to bonds in a flight to safety.
Stage 3: The Medium Future: As time goes on, interest rates will creep up even further: massive money printing will cause rising inflation, and rising inflation will bring rising interest rates. High inflation and high interest rates will not occur overnight. It will happen over time. The more time goes by, the greater risk to bonds. Rising interest rates will clearly make bonds fall more and more. As money printing and other manipulations begin to backfire, inflation and interest rates will decline much further.
Leading up to and during the Aftershock, bankruptcies, decreased lending, and a massive exodus of foreign investments will lead to a collapse in the stock market, and suddenly, even the most rock solid companies will start to look like another Lehman Brothers…also the bond market will effectively shut itself down.
The federal government can and will ease this pain as long as it can by printing more money, but eventually this medicine becomes poison. With tax revenues dropping due to high unemployment and expenses skyrocketing due not just to inflation, but to bail outs and guarantees on pensions, insurance, and other debt obligations, the government has no choice but to go deeper and deeper into debt.
Treasury debt will not be able to be paid. Guarantees won’t be covered, expenditures will be out of control, when the government can no longer borrow money…this will be where the most rock solid of all debtors, the U.S. government goes into default. during this Aftershock, the government safety nets for bonds will fail because the government will not have the money to cover them. For deeper information on how to respond to these bond crashes as they evolve you might go to www.aftershockpublishing.com.
Source: The Aftershock Investor a crash course in staying afloat in a sinking economy by David Weidemer, Robert A. Weidemer, and Cindy S. Spitzer