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Big Changes Afoot in Bond Land

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11/17/2010

There’s a whole lot of change going on in the bond market. Since the midterm Congressional election, and since the Federal Reserve announced its plans to print our way out of the fiscal doldrums, bond yields have been on a decided path higher. Moreover, there’s been a big drop in the value of municipal bonds.

Rising long-term interest rates, i.e., rising bond yields, is definitely a theme that has come into its own. Now that the Fed has made the decision to implement quantitative easing part II, or QE2, with the purchase of $600 billion in longer-term Treasury bonds at the rate of $75 billion per month for the next eight months, yields are on the rise. But the Fed’s quantitative easing isn’t the only reason for the changing bond landscape. (I will return to discussing QE2 shortly).

Consider for a moment all of the borrowing that will have to take place by countries around the world, and you just have to surmise that interest rates are bound to continue climbing. According to estimates from the International Monetary Fund (IMF), the amount of money that advanced-nation governments will need to borrow next year is staggering.

In just 2011 alone, new borrowing around the globe will be a mind-blowing $10.2 trillion. These are debt levels unseen since the aftermath of World War II. Next year, the U.S. government will have to borrow $4.2 trillion, according to the IMF. With so much borrowing needed, interest rates are going to take off.

Another big part of the changes afoot in bond land is the recent plunge in municipal bond prices. To give you a sense of just how big the selling has been in the municipal bond sector, take a look at the chart below of the SPDR Nuveen Barclays Capital Muni Bond Fund (TFI).

As you can see, the fund plunged through both the short-term, 50-day moving average and the long-term, 200-day moving average in a matter of weeks. So, why has the muni bond segment tanked?

The answer to this question has multiple facets. In fact, it’s the convergence of several trends that’s brought big trouble to muni land. First, we have those rising long-term Treasury bond yields which drive up interest rates in general. The chart below of the 30-Year T-Bond Yield ($TYX) clearly shows the trend toward rising rates. As you can see, 30-Year T-Bond yields recently spiked above their short- and long-term moving averages, almost in diametrically opposed fashion to the price action we see in TFI.

Besides the overall spike in interest rates, munis are confronting a glut of new bonds flooding the market. My home state of California is on the verge of conducting a bond sale amounting to some $14 billion. This comes as the state’s budget wallows in red ink. And it’s not just California that’s in trouble. The recession has caused many counties and municipalities around the country to suffer fiscal hardships and, as such, investors are more and more reluctant to either buy new muni bonds, or to hold onto the ones they already own.

Finally, there’s some real uncertainty about whether Congress will extend what’s called the “Build America Bond” program, which for two years has allowed states and municipalities to issue taxable debt subsidized by Uncle Sam. This program has reduced the supply of conventional tax-free muni bonds, helping to keep yields low. If, however, the program isn’t extended beyond its Dec. 31 expiration, bond issuers would be forced to ramp up borrowing in the tax-free market in 2011, and that also has the potential of creating more supply problems.

If you own municipal bonds here, I suggest that you consider moving your money to safer ground. The last thing your portfolio can afford is to get sucked down into a vortex of muni-bond value destruction.

The Fed Gets Skewered by a Cartoon

Every once in a while, a humorist or satirist hits the proverbial nail on the head. This is certainly the case with a viral video posted on YouTube titled, “Quantitative Easing Explained.”

This animated video features two cartoon bears discussing the Fed’s recent QE2 bond-buying plan and the motivation behind it. The video is one of the cleverest, most insightful and funniest things that you will ever see. I strongly recommend that you watch this short, six-minute-plus video as soon as you can. (Warning: there is some very mild adult language at the end of the video, so if you are extremely sensitive to this kind of thing, you may not want to watch it.)

I think what makes this video so important is that it skewers the Fed for being right about “nothing” over the years. The unknown authors of the video also point out how bizarre it is that “The Ben Bernak” has “no business experience… no policy experience (and) … has never run in an election.”

The last time I looked, this video had been viewed nearly 1.2 million (yes, million) times. Fox Business Network financial reporter extraordinaire Charles Gasparino even wrote an article for The Daily Beast about this video. In the piece, he says that a spokesman on Mr. Bernanke’s senior staff has seen the video, although that spokesman wouldn’t say whether the chairman also has seen the video.

I think that after you watch this video, you’ll know more about the Fed’s QE2 than you did before. You’ll also likely laugh really hard at both the absurdity of the QE2, and the computerized voice delivery of the two cartoon bears.

The Most Important Teleconference of the Year

On Saturday, Nov. 6, I hosted what I think was the most important investor teleconference of the year. The title of this presentation was “The Election’s Over -- Now What Do I Do with My Money.” As the title suggests, we talked about the new makeup of the next Congress, but more importantly, we talked about how this new divided government will affect your investments.

In addition to the new power mix on Capitol Hill, we also talked about the ramifications of the Federal Reserve’s latest efforts to stimulate the economy, and what kinds of opportunities are ahead for investors based on the Fed’s recent action.

Among the topics discussed in this call were:

If you want to get my latest take on all of the huge news events, and how investors can take advantage of the current and future conditions in Washington and Wall Street, you simply have to listen to a replay of this call ASAP. To listen to a replay of the call, simply click here now.

ETF Talk: Seeking to Profit from Weakening Treasuries

The Fed’s recent decision to buy $600 billion in Treasury bonds gave the stock market at least a short-term boost and opened the path for investors to profit outside of buying equities. Yesterday’s market retreat shows why you may want to avoid having too many of your investments tied up in stocks. Indeed, yesterday’s trading led to drops of 1.59% in the Dow Jones Industrial Average, 1.75% in the NASDAQ and 1.62% in the S&P 500.

If you want an alternative to equities, consider the ProShares Short 20+ Year Treasury (TBF), a rising-interest rate exchange-traded fund (ETF). The fund seeks the inverse performance of the long end of the Treasury bond market and lets investors profit when bond yields climb. I have recommended the fund in my High Monthly Income and Successful Investing investment newsletters, as well as in my weekly ETF Trader service. I am pleased to report that, as of the close of trading yesterday, all of those positions were profitable.

Here are several reasons why you may want to own TBF right now. First, the Fed’s quantitative-easing (QE2) decision to buy $600 billion in bonds should be good news for a fund that shorts Treasuries. Second, interest rates have begun to rise since the Fed’s QE2 announcement. Finally, the Fed’s continuing efforts to stimulate the economy have chipped away at the value of the U.S. dollar versus rival foreign currencies.

As a short fund, TBF is a way for you to bet against long-term Treasuries. TBF specifically seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments, that correspond to the opposite of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Index. The index includes all publicly issued, U.S. Treasury securities that have a remaining maturity greater than 20 years and are fixed-rate, non-convertible, investment grade and denominated in U.S. dollars.

The chart below shows that TBF has enjoyed a big jump since early October but has pulled back in recent days. If you think the dip is a short-term reversal that simply offers a reduced price to let you climb aboard the next wave that will take TBF higher, you may want to invest in this ETF in the near future.

For advice about which ETFs to buy and to sell, I urge you to sign up for my ETF Trader service by clicking here. As always, I am happy to answer any of your questions about ETFs, so do not hesitate to contact me if you have one. To send your question to me, simply click here. You may just see your question answered in a future ETF Talk.

Get Your Precious Metals Watch List

The ETF universe now is teeming with more than 1,000 funds. Yet there is one asset class, particularly this year, that really has captured everyone’s attention -- and that’s precious metals.

Precious metals, like stocks and bonds, are an asset class which represents a great deal of risk along with the potential for big rewards. One of the biggest challenges confronting precious metals investors is dealing with the tremendous volatility in the sector.

We’ve seen this volatility in the premier precious metal, gold, since the value of the yellow metal has gyrated wildly over the past 12 months. Because gold and other precious metals generally are non-stock, non-bond correlated investments, they’ve become very attractive to individual investors, despite their propensity for volatility. This low market correlation is a crucial component for investors who seek diversification within their portfolios.

In our latest special report, “The Fabian Precious Metals Watch List,” we’ve identified 20 precious metals ETFs that give you access to both the bullion and mining segments of the best precious metals available to investors today. To get your free report, simply click here.

On Government and Disease

“When one gets in bed with government, one must expect the diseases it spreads.”

--Ron Paul

Whether you love Texas Congressman Ron Paul, or whether you hate him, one thing for sure is that you know where he stands on every issue. Here the Congressman speaks of the perils of government involvement in all walks of life. Paul has become famous for trying to get Congress to authorize an audit of the Federal Reserve. He’s also an opponent of the central bank’s current monetary policy. Paul is a dissenting voice that definitely deserves to be heard in our nation’s political discourse.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars or anything else. Click here to ask Doug.

P.S. I encourage you to listen to my recent teleconference about how to invest your money following the Nov. 2 midterm Congressional election by clicking here.

P.P.S. My publisher, Eagle Financial Publications, is now on Facebook. Click here to see our page and be sure to become a fan when you get there.

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