What Happens to These Folks When the Bond Bubble Bursts?

Phoenix Capital Research's picture

For 40 years, the financial world has experienced a bull market in bonds. What this means is that for 40 years, bond prices have risen while yields fell.  As yields fell, it became easier and easier for investors to borrow money.

 

For simplicity’s sake, let’s focus on the 10-Year Treasury.

 

The 10-Year Treasury is the benchmark for risk in the financial system. All asset classes and interest rates are ultimately priced relative to the 10-Treasury yield.

 

The reason for this is that lending money to the US is considered to be the effectively “risk free” because A) the US can tax its citizens to pay you back or B) can print money. This, combined with the US’s low rate of defaults (the US has never officially defaulted on its debts, though there have been metaphoric defaults e.g. when we left the Gold standard)

 

Stocks, corporate bonds, mortgages, auto loans, emerging market stocks… everything you can name are ultimately priced based on their perceived risk relative to the “risk free” rate of lending money to the US for 10 years. After all, if you can earn 4% “risk free” why invest in a more risky investment unless you can earn more?

 

This is the basic philosophy underlying all modern financial analysis. It is applied by everyone from mutual fund managers to C-level executives looking to decide on whether to fund an expansion or not (again, if they can make 4% on their case “risk-free” any business venture they pursue should hopefully yield more than this if it’s worth the risk).

 

With that in mind, let’s take a look at the history of the 10-Year Treasury.

 

In 1980, at the depth of the last bear market in bonds, the 10-year was yielding around 16%. This meant that in general, if you borrowed money at that time, you would be paying more than 18% per annum on the loan (anyone who lent you money instead of the lending to the US Government by buying a Treasury, would be expecting a much higher rate of return for the greater risk).

 

So, if you’d borrowed $100,000 in 1980, you’d need to pay at least $18K to finance the loan per year (for simplicity’s sake, I’m not bothering to include principal repayments).

 

Obviously, with interest rates at this level, you’d think twice before taking out that loan.

 

The great bull market in bonds started in 1983. Since that time the yield on the 10-year has fallen almost continuously.

 

When considering this it is important to assess two things:

 

1)   The psychological resistance to borrowing money/ investment risk shrank year after year.

2)   The overall timeline and its impact on different generations.

 

For 40 years, with few exceptions, it became increasingly cheaper to borrow money. The flip side of this is that the overall “risk” of the investment world (remember that all investments move in relation to “risk free” 10-year Treasuries) shrank on an almost yearly basis for 40 years.

 

This was a truly tectonic shift in the investment landscape occurring over four decades. During that period we had the Long-Term Capital Crisis, the Asia Crisis, the Ruble Crisis, the Peso Crisis, the Tech Crash AND the 2008 Meltdown.

 

Throughout this period, despite these numerous crises, risk became increasingly cheaper. This is truly astounding and can be largely traced to the Federal Reserve (more on this later).

 

The second item is important because this time period (40 years) encompasses at least 2 if not 3 generations. A 30 year old who shied away from borrowing money at 18% in 1980 was 50 with children in their teens by the year 2000. That individual’s children would grow up in an era in which interest rates were below 10% for their entire lives and below 7% for as long as they could remember.

 

From an investor perspective, this means that any professional investor who was working in the late ‘70s/ early ‘80s would now be retired (e.g. a bond fund manager who was 25 in 1980 would now be 65).  Put another way, there is an entire generation of professional investors aged 22-60 who have never invested during a bear market in bonds (a period in which risk was generally increasing).

 

In the near past, the last time the Fed raised rates was in 2004. And that was the first rate raise in four years. Put another way, the Fed has only raised interest rates once in the last 14 years.

 

So not only are we dealing with an investment landscape in which virtually no working fund manager has experienced a bear market in bonds… we’ve actually got an entire generation of investment professionals who have experienced only one increase in interest rates in 14 years.

 

Whenever rates rise, which they will, the investment herd will be out of their depth.

 

This concludes this article. If you’re looking for the means of protecting your portfolio from the coming collapse, you can pick up a FREE investment report titled Protect Your Portfolio at http://phoenixcapitalmarketing.com/special-reports.html.

 

This report outlines a number of strategies you can implement to prepare yourself and your loved ones from the coming market carnage.

 

Best Regards

 

Phoenix Capital Research

 

 

 

 

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PGR88's picture

Why does the author talk about 40 continuous years of declines?

If bonds bottomed in 1983 - that's more like 30 years.

If the author can't get simple math right, it tells me he is just spewing his ideas and emotions on paper

lasvegaspersona's picture

Volker COULD raise rates. If Yellen does that now...KaaPoW!!! Equities fall and so does Olympus.

I see the Fed continuing to use bond market derivatives to keep the 10 year low (probably 2.5% or lower) forever...or until the dollar goes away.

Bernacke does not expect higher rates 'in his lifetime'. This can be achieved because the Fed can BUY lower rates...remember back when mortgage rates were 8% but if you paid a point or so you could 'buy' the rate down to 7.5%? It is kinda like that. The Fed spends a few billion every month, in the OTC markets where it is not obvious, and magically the rates go down.

We are in a period where the situation for the dollar is so precarious that the Fed must act or the dollar dies quickly. I expect them to keep acting as long as they can.

I have equity assets for this period of time and physical gold for when they eventually fail.

We are not in normal times and this is not a normal market. When it is over we will look back and say: 'Wow, how did we miss that!"

Fuh Querada's picture

My dog craps better stuff than this.

madbraz's picture

What an idiot.

andrewp111's picture

Can't this stupid clown from Phoenix Capital Research do simple math? 1981 was 33 years ago. Where does he get 40 years from? If the bond bull continues until 2021 it will be 40 years, but right now talk of a 40 year bond bull is premature.

LawsofPhysics's picture

Must be a post from 2009...

What are interest rates in the E.Z. again?