Bonds Aren't Supposed to Crash

More Fed-speak... Bonds have more to say than the Fed... Bonds aren't supposed to crash... A guaranteed way to lose money... An unusual global trend... An 'emergency meeting' in Europe... How to take smart chances...

Today, we were 'treated' to more Fed-speak...

As we expected – after what we saw from the latest round of inflation data and market reaction over the past several days – the Federal Reserve raised its benchmark lending rate by 0.75% this afternoon in an effort to fight inflation.

We won't get into all the details. You've heard a lot of it before, including a few familiar lines that Fed Chair Jerome Powell delivered again in a press conference explaining the decision. He said, among other things...

Inflation remains well above our longer-run goal of 2%... Inflation has obviously surprised to the upside.

I (Corey McLaughlin) couldn't believe that one... Like last month, they're still "obviously surprised."

There were some worthwhile insights, though...

Powell put on the face that more rate hikes will come and that, notably, the Fed's projection is to raise rates as high as 3.5% by the end of this year... ending this rate-hike cycle as high as 4% next year. But he also spent a lot of time admitting that nobody really knows...

One reporter asked if a federal-funds rate of 4% – more than double what it is right now, even after today's rate hike – would be enough to "break the back" of inflation. Powell responded...

It's in the range of plausible numbers.

That's not exactly an encouraging opinion.

Another reporter asked if the economy would be due for more than "some pain," as Powell had previously said, since the central bank hikes rates more aggressively to slow demand for goods and services in the economy (and hopefully slow inflation). Powell paused at that one, then said...

I do think our objective is to bring inflation down to 2% while the labor market remains strong. What's becoming more clear is that many factors that we don't control are going to play a very significant role in whether that's possible or not.

By that, he meant commodity (oil) prices... the war in Eastern Europe... and the renewed threat of COVID-19 lockdowns in China. Powell again admitted – as we've also said – that the Fed's "tools" of interest-rate hikes don't influence those factors in the global economy today. The Fed can deal mostly with demand, not supply.

OK, so if Powell "doesn't know," who or what does?

Well, let's look at something that does know... It's not a person, a think tank, or a government agency. It's a collection of people who deploy a lot of money in a certain market sector. I am talking about the typically sleepy ol' U.S. Treasury bond market.

This market has been lively lately... because of inflation and its uncertain path.

Bonds gone wild...

Before talking about bonds, particularly government bonds, I usually start with some kind of qualifier along these lines: Please, don't close your e-mail app or web browser...

I know most people think of bonds as boring. They should be. After all, in most cases, they're loan agreements investors make in exchange for a promised return. They may have different risks, yields, and time horizons involved depending on the form, but that's the gist.

Another important, related qualifier...

The low-yielding government bonds in most people's 401(k)s that I'm about to talk about are a different animal from the distressed corporate bonds our colleagues Mike DiBiase and Bill McGilton recommend in our Stansberry's Credit Opportunities newsletter. I'll discuss those later today.

For now, I'm talking about U.S. Treasurys.

There are U.S. Treasury bills (which have a duration of less than one year), Treasury notes (maturity between one year and 10 years), and bonds (maturity longer than 10 years). To keep things simple, I'm going to refer to everything as "bonds" from here on out.

If high-quality stocks are the star quarterbacks and cryptocurrencies or small-cap stocks are the exciting young prospects of the investing world, "risk free" low-yielding government bonds are more like the offensive linemen in the trenches...

They should do their job quietly without calling attention to themselves. They shouldn't be crashing...

But, like offensive linemen, the bond market is important. And its behavior can say a lot about market sentiment and reality. So when we talk about bonds, it's because something funky or telling is happening.

That's the case today.

On Friday morning, the latest inflation data caused more people to think that the Fed could raise its overnight lending rate by more than the 0.50% most market observers had been expecting for months. Since then, the typically slow-moving bond market has gone wild...

Things picked up late on Friday after word leaked out to media outlets (likely on purpose, since the Fed was in a media "blackout" period) that the central bank would probably raise rates by 0.75% today.

The yield on the widely followed 10-year Treasury note hit an 11-year high yesterday of 3.48%. That is a massive, nearly 12% percent move from where it was on Friday morning before we saw the latest Consumer Price Index ("CPI") inflation data.

Similarly, the 2-year Treasury yield is 17% higher (3.33%) than it was Friday morning (2.83%). And the 30-year bond has gained 5% since Friday morning. Treasury yields pulled back a little today, but they are still higher than they've been in a decade...

We just saw basically a mini bond crash...

Longtime subscribers understand this key point... Bond yields trade inversely to bond prices. So a 12% spike in yields means the price of a 10-year Treasury note has fallen by 12% in just a few days.

Not only is that a large practical open loss for bondholders, but it's also a signal that something is wicked in the economy right now...

This sell-off means that lots of folks are no longer willing to hold "safe" government bonds – more than at any time in the past decade.

This yield spike is likely also a symptom of the Fed finally starting to pare back its $9 trillion balance sheet, which includes billions of dollars of bond holdings. The central bank has become the biggest buyer in the bond market, which is a long-term problem on its own.

With everyone more aware of inflation, investors are figuring out what our colleague Dr. David "Doc" Eifrig warned this time last year...

A 'guaranteed way to lose money'...

Doc has consistently warned that the conventional 60/40 stock-bond portfolio was going to be in serious trouble given today's environment...

As I quoted Doc in the July 1, 2021 Digest, after he went on camera to share his "retirement wake-up call," which also included a stern warning about overvalued stocks...

U.S. bonds used to be called risk-free returns. These days, we're calling them return-free risk. With bond yields so low, plus taxes, plus looming inflation, you could be putting about half of your portfolio into an asset almost guaranteed to lose money.

Let me say that again, and please pay attention to this: with 20% to 40% of your portfolio in bonds, I can guarantee you will lose money over time. Yet this is still the narrow strategy most financial planners would recommend to you.

And as I continued...

It doesn't take much to see the problem here, though... A 10-year U.S. Treasury note pays a 1.5% yield today, while a 30-year U.S. Treasury bond will pay 2.1%.

If the Federal Reserve's "official" inflation numbers are running higher than that (around 4% year over year, as of May)... and many prices elsewhere are rising by greater rates... on balance, you're losing money by owning "safe" bonds.

If 40% of a portfolio is dedicated to a low-return asset class that won't keep up with inflation, it's the opposite of safe. They're going to drain your retirement account and purchasing power... before the government does anything about it, if at all.

I hope you heeded our advice... A year later, inflation is ravaging the bond market – and 60/40 portfolios, along with similar passive strategies, are all over the place. But if you're worried that it's too late to prepare or adjust your portfolio to this reality, I'm here today to tell you it's not.

And you should consider doing just that.

Bond struggles are a global trend...

Check out this stunning chart below from market analyst Jim Bianco, who gives advice to institutional investors on Wall Street...

This year is by far the worst-performing year for government bonds across the world in the past 20-plus years, as measured by the Bloomberg Global Aggregate Bond Index, which accounts for $61 trillion invested in more than 28,000 bonds...

There's a lot of lines on the below chart, but the thick blue one is the important one. So far in 2022, the global bond market is down 15.6%, an outlier among the rest. The second-worst performance during the span Bianco shared was a 5.17% loss in 1999...

As Bianco noted in an associated Twitter thread that's worth your time...

What is happening in 2022 (blue) was thought to be impossible, even as late as last year. Take this chart to mean there is incredible stress in bond markets worldwide...

The markets know this which is why [this] chart is collapsing. Rates have to go a lot higher...

Normally, you'd expect central banks around the world to step in right about now and do some form of stimulus to change the path of bond prices...

But as we've warned so many times, the Fed and other central banks are actually doing the opposite of what they usually do.

Because inflation is so high, despite uneasiness in the markets, central banks are making financial conditions tougher. They're raising interest rates and pulling back on other stimulus measures to try to avoid the worst impacts of higher costs in their countries.

That's the plan for now – mostly...

If you think things are bad in the U.S., look no further than Europe for a fresh dose of perspective...

Part of the global bond market sell-off has to do with the major inflation problems facing Europe... heightened by an energy crisis tied to Russia's invasion of Ukraine and the ensuing responses.

Just a few days after supposedly halting stimulus measures to fight inflation, the European Central Bank called an "emergency meeting" this morning to talk about restarting them, at least in part.

Our Stansberry NewsWire editor C. Scott Garliss shared this news with us today. Get ready for what sounds like echoes of the financial crisis...

The European Central Bank is worried about the blowout in the bond yields of Italy compared to Germany. The difference in yield has widened from around 1.3% at the start of the year to about 2.2% currently.

The problem is Europe has countries in the south who are highly indebted compared with their northern neighbors who aren't. The southern countries expanded their debt burden during the pandemic because debt-to-GDP rules were loosened.

So, as the prospects of tightening rise, bonds are dropping and yields are rising.

Bond investors are worried slowing global growth will hurt the weaker economies in Europe more, so countries like Italy are seeing borrowing costs rise faster while the change is not as severe in Germany.

The ECB announced this morning that it will introduce "new tools" to stop this from happening, even though it's supposed to be ending asset purchases. As Scott said...

It's labeling the problem as fragmentation.

But end of the day, it's likely to wind up buying debt from the likes of Portugal, Ireland, Italy, and Greece (dubbed the PIIGs during the financial crisis) and not doing the same for the stronger nations like Germany, Holland, and Denmark.

The net effect will be a weaker euro, which could cause additional dollar strength, potentially weighing on the outlook for S&P 500 companies (45% of revenues come from abroad).

In the end, this means stocks and government bonds are correlated – downward – for the first time in decades. Most people haven't prepared for this sort of thing because they've never seen it before.

The lesson: Listen to the bond market more than 'Fed speak'...

Could this be the worst of this bond market rout?... Sure, it could.

Maybe inflation will ease so significantly in the second half of this year, the Fed doesn't feel a need to raise interest rates too high. In this scenario, its benchmark interest rate could stick around 2.5% – assuming the all-but-certain rate hike everyone expects next month.

In that case, 3% or higher yields on government bonds would become attractive again to the folks who are ditching them today. In that scenario, investors would start snapping them back up... pushing prices higher and yields back down again.

But maybe inflation will stay higher than anticipated – a decent bet. If the Fed keeps hiking rates in response – which today it indicated it will to near 3.5% by year-end – the same story we're talking about today could be written months from now once again...

Bond yields will keep going up (and bond prices down)... and this would create pain in the supposed "risk-free" bond market that most people simply don't expect. If you take nothing else from today's Digest, make it this: Don't let this possibility catch you off guard.

That's why we've been warned against conventional wisdom of "set it and forget it" strategies that have just "always worked." In today's climate, having generous allocations to cash and "hard asset" alternatives such as gold is critically important.

Remember, Rule No. 1: Don't lose money. Think about the long term and preserve capital to put to use on better opportunities in the future. In the meantime, consider making sure you own high-quality, low-volatility stocks in your portfolio today.

From that solid base, you can take smart chances...

It might be a few bets on prices going down – the kind that we mentioned our Ten Stock Trader editor Greg Diamond has been recommending all year long... and his subscribers having been making money from as a result.

It might be listening to someone like Joel Litman, the founder of our corporate affiliate Altimetry, who we mentioned yesterday. He is known for finding trends, hidden truths, and opportunities that many others in the market miss.

As we said yesterday, Joel – who called the 2008 and 2020 stock market crashes – believes we actually have something bigger than a crash to worry about now. He's predicting a massive financial "heist" could sweep the country soon...

But he's also sharing one move right now that could make you massive profits as it unfolds... far greater than anything you could make on gold, ordinary stocks, bonds, or cryptocurrencies. You can hear more detail directly from him here.

Now is also the time to consider acting like some of the best-known investors in the world. Should the bond blowup get worse, you'll want to be ready to pounce on the opportunities that come up in the corporate-bond market.

We're not there yet, but the current stress on bond prices could turn into a full-fledged "credit crisis" – where yields get so high that many businesses won't be able to afford to pay off their own debts. This is where our Stansberry's Credit Opportunities strategy flourishes.

It might sound counterintuitive, but in Credit Opportunities, editor Mike DiBiase and analyst Bill McGilton are eagerly anticipating the next crisis... As Mike said in our May 29 Masters Series interview...

You can gauge fear in the credit market by looking at what's called the high-yield credit spread... It's the difference between the average yield of less creditworthy junk bonds and the yield of similar-duration U.S. Treasury notes.

It's measured in basis points ("bps"). A spread of 600 bps means that junk bonds yield 6% more than U.S. Treasurys. That's about the average throughout history.

Today, the spread is around 500 bps, below the historical average. But it has been rising. At the start of the year, it was around 300 bps. That tells me the credit market is starting to worry.

You see, Mike and Bill recommend distressed corporate bonds. They find bonds floated by good companies that can afford to pay back their bondholders, but that trade at a discount because of sentiment in the bond market in general.

Should one of the knock-on effects of rampant inflation be the next great credit crisis, which Mike believes it will, this will mark a moment to "back up the truck" and buy corporate bonds that are obligated to return your capital plus a generous amount of interest.

In other words, when most everyone else is panicking, following Mike and Bill's recommendations will be one way you can do the opposite... and make money from the next crisis. Click here to learn more details.

We're not at crisis levels yet, but we're getting closer... The bond market is saying so.

Gold Is the 'Anti-Dollar'

Willem Middelkoop, founder of the Commodity Discovery Fund, tells our editor-at-large Daniela Cambone we have entered the "Big Reset." He says "it's time to get conservative and defensive" with your capital... and explains why gold is the "anti-dollar."

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 6/14/22): Continental Resources (CLR).

In today's mailbag, feedback on yesterday's Digest... What say you? As always, send your comments, questions, praise, or rage to feedback@stansberryresearch.com.

"Corey, Good article. Add it up and 33% to 50% down from highs is now on the table. Rate raises don't fix inflation... Give a stupid man a club and he will use it." – Paid-up subscriber William B.

"Statements from/about Powell doing 'anything necessary' to rein in inflation are laughable. He will have to choose between (1) allowing inflation to continue (even if somewhat abated) and (2) bringing on a recession and exploding the ticking corporate debt bomb making it worse. The politicians they are and the ones whom they answer to will always take option (1).

"Printing more $$ and spreading it around allows phony explanations of how the 'bad guys' (rich corps. and politicians who advocate for fiscal sanity instead of ever bigger giveaways) are responsible for the misery index and not the politicians and their MMT geniuses." – Paid-up subscriber Robert B.

"What all of this misses is this:

"The U.S. government has a huge balance sheet obligation. If interest rates go to even 5%, the U.S. government can't meet its debt obligations and discretionary spending needs. And as interest rates rise, businesses fail, and the tax revenue decreases, increasing the government's need for money just to meet debt obligations, much less discretionary spending needs.

"It is a death spiral from which there is no return. And the bastards will print money to meet debt obligations/discretionary spending needs which just increases the interest rates if we are to fight inflation, further killing businesses and tax revenue.

"Economy is doomed, as you've been saying for many years. Inflate or die. Either is death. We are there, and it is us." – Paid-up subscriber Walt H.

Corey McLaughlin comment: Well, on that happy note...

But, no, I hear your points, and thanks for the note.

We didn't get very far into this part of the story yesterday, which was more laying out the facts. But the scenario you describe falls under one of the potential "knock-on consequences be damned" that we mentioned.

To your point about the next round of money-printing that will inevitably come if or when things get worse for the economy, I think you might agree with this observation that Ben Carlson, who authors the financial blog "A Wealth of Common Sense," made the other day...

It's true...

This is why we always say artificially manipulating the economy in the short term doesn't come without long-term consequences. You just won't hear that from people making decisions today.

All the best,

Corey McLaughlin
Baltimore, Maryland
June 15, 2022