For years now, global economies and financial markets have been caught in the vice-grip of deflation.
For years, global central banks have pushed back with extraordinary easy-money policies, delivering ultra-low and even negative interest rates worldwide.
And for years, financial commentators … including my colleagues Larry Edelson, Mike Larson and myself … have been predicting this will end very badly one day – when the spell of omnipotent central banks is forever broken and investors reject government debt of any kind.
Well, 2016 may go down in the financial history books
as a real game-changing year:
The end of the great bull-market bubble in bonds.
It was fun while it lasted. After all, the great bull market in bonds persisted for 35 years!
From a peak above 15% in 1981, yields on the 30-Year U.S. Treasury Bond steadily declined to a low of just 2.1% earlier this year.
And since bond prices move in the opposite direction of yields, this meant windfall profits for bond investors for several decades.
But now the game has changed, and it means a major shift is already underway across financial markets.
As you can see in the chart above, yields on the benchmark 10-Year Treasury note were at a low of 1.3% as recently as July, but spiked higher to nearly 2% this week.
What’s different this time is that previously, bond yields consistently declined whenever uncertainty and stock-market volatility were on the rise, but NOT this time.
This time yields are rising as investors unload bonds and prices tumble.
Now, a move in bond yields from 1.3% to almost 2% may not sound like such a big deal, but consider this: A paltry 1 percentage point rise in yields translates into a roughly 7% loss in the principle value of global government and corporate bonds.
That’s equivalent to a $3.4 trillion hit to the global bond market, a loss large enough to erase several years’ worth of interest payments!
And why are bond yields suddenly selling off worldwide?
The short-sighted seers on CNBC will tell you it’s due to fears about an impending interest-rate hike from the Federal Reserve. But I don’t believe that for a minute.
Look, the Fed’s desire to “normalize” monetary policy and to begin raising rates has been the worst-kept secret on Wall Street.
After all, the Fed ended its quantitative-easing program, when it bought government bonds to suppress interest rates, two years ago, in November 2014.
Then this past December, the Fed made its first move in over a decade to raise short-term interest rates.
Yet 10-Year Treasury prices were higher back then than they are right now. So, you can’t pin the blame for recent bond market losses on fears of rising rates alone.
What’s really happening?
Rising fears of inflation, that’s the real game-changer.
Here’s a fact that wasn’t widely reported on CNBC or in the Wall Street Journal this week: On Halloween, the Fed’s preferred measure of inflation, something called the PCE deflator, was reported to have risen 1.2% in September from a year ago.
But this time last year, PCE inflation was up only 0.2% in the year ending September 2015. In other words, inflation is accelerating.
In fact, prices are rising at a 2.1% annual clip over the past six months alone … a rate that surpasses the Fed’s publicly stated 2% inflation target.
No surprise when you consider: American wages are finally on the rise; commodities, including oil, are rebounding; oh and healthcare and tuition costs continue to soar at double-digit rates.
And it’s not just here at home either. Measures of inflation are also on the rise in Europe and the United Kingdom, too, as you can plainly see in the chart above.
Bonds are selling off due to fears that the Fed, and many other central banks are already behind the curve on inflation, which I define as the real cost-of-living, not the contrived government data.
Mind you, I’m not saying we’re in store for the 1970s-style inflation with soaring prices for everything from food to fuel. But investors have gotten so accustomed to years of low inflation, and have grown so complacent it will continue, that even a mild acceleration in prices – with interest rates at record lows – can be a major game-changer for financial markets.
How will this impact your investments?
We’re seeing the trends already.
Stocks that benefit from rising prices, including energy and financials have been outperforming the stock market.
Financials are up 6.6% since the end of June, the second-best performing sector behind technology, which is another sector that typically performs well amid rising inflation. And energy stocks are up 14% year-to-date.
Meanwhile, the most interest-rate sensitive stocks, including utility and telecom shares, are getting thrashed – both sectors have declined 6% since July 1.
Bottom line: I’m seeing growing evidence that interest rates are likely headed even higher so long as inflation remains on the rise. This means the long-anticipated bond market bust may finally be unfolding now, right before our eyes.
Stocks and ETFs with bond-like qualities are vulnerable to get dragged down along with bond prices. Be sure to adjust your own portfolio holdings accordingly.