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Bond Bubble Is Here

Mother's Little Helper portfolio was DOWN today -$538.90 (+0.45%)

Overall GAIN YTD: +$2,149.37 (+1.83%).

Our benchmark index, the S&P 500 is DOWN Year-To-Date (+1.47%)

"“This would be a great world to dance in if we didn’t have to pay the fiddler."

- Will Rogers

I made my buys for the year on December 28, 2017, see the new portfolio here (Click Here).

  • The Fed controls short term interest rates; rates are rising

  • The market controls long term interest rates; rates are rising

  • Foreign investors use dollars to hedge long term treasury buying; There is a dollar shortage in foreign markets; dollar shortage increases cost of hedging

  • Selling pressure on US 10-year will accelerate as overseas treasuries look more attractive

I’ve never rung the alarm bell when it comes to investing. During the financial crisis I’m certain I said, “This too shall pass”, quoting my father, a Shearson branch manager with almost 50 years in the business. Today I’m giving the bell one good whack, I hope someone is listening because a lot of people could get hurt if they ignore what's happening in the bond market.


Two years ago I was spouting off to anyone who would listen that the U.S Bond market was in a bubble, that the bubble was unsustainable and that in the near future we are going to see bond prices collapse as bond yields rise. The reciprocation of that time is that I got invited to fewer parties. As a student of history I'll walk us all through the milestones that got my thinking to the current position I hold.

October 2016

Back in October 2016 The World Economic Forum was talking about the return of a dollar shortage. Dollar Shortage was a term coined in the post-world war II era where Europe and Japan struggled to rebuild because access to the liquidity of US Dollars was very difficult; The Marshall Plan in part helped alleviate this issue. We saw the term show up again in 2008 during the financial crisis. The problem today is that we don’t have anything resembling the Marshall Plan and rates are so low that there isn’t much room for the Fed to do what they did in 2008.

February 15, 2017

On February 15, 2017 I wrote a post that recommended on Day 43: Buy Bond Market Equivalents My rational was that these stocks paid a better dividend and they had the opportunity to appreciate in value. My primary concern at the time was that no one should lock up their money in low yielding bonds if interest rates were going to keep rising.

May 2017

In May 2017 The Financial Times rung the warning bell of The Dollar Shortage, its effects on emerging markets and holders of fixed income instruments (Bonds) and the stock market.

August 4th 2017

Last year I started writing this blog. Fearing the same retribution I avoided the topic of bonds until August 4th 2017, my birthday. For my birthday I decided to write the post titled “Bond Market Bubble”? While the post was well read I don’t recall getting the flood of emails I get around a stock pick or some of my wilder prognostications.

December 2017

In December 2017 Blomberg published a piece stating that The Dollar Shortage is here, it’s real but don’t worry, it’s temporary. A 4 year slide is not temporary, that’s a trend.

While the article’s author did some good research, what wasn’t asked is what happens to holders of long duration bonds as this Dollar Shortage progresses, rates rise and bond prices continue to decline. That’s a really important question, especially for readers of this blog who might be depending on bonds for current income.

January 13th 2018

On January 13th 2018 I wrote the post, “Shorting US Bonds”. No ‘click-bate’ question mark after the title, no discussion with my readers, I simply did it. Why, because I felt the bubble was about the strain and that soon we would see a dramatic shift in the bond market. My action at the time was to buy shares in the TBT (ProShares UltraShort 20+ Year Treasury), as bond price come down the TBT goes up, it’s a hedge against falling bond prices or rising yields however you like to view it.

March 2018: Alan Greenspan agrees and says we're in a bond market bubble

What I think Will Happen

The Fed will keep raising rates as the U.S Economy continues to expand and grow. Given the anemic growth we had from 2009-2016 and the dramatic growth of the last few quarters I suspect that we are in the 4th or 5th inning of a 9 inning game. Said plainly, rates are going higher for a long time to come. Higher rates indicate a strong economy, things are good. But there is a negative side and this time around we have a really unusual negative side. All the Quantitative Easing that was done to alleviate the financial crisis loaded up the Fed’s balance sheet to the tune of $4.5 trillion in bonds and mortgage backed securities. Now we are going into a period of ‘Quantitative Tightening’; the Fed has to unwind all that debt. In fact I wrote a post about this debt last year claiming that it isn’t possible for the Fed to get rid of the debt for all the reasons I’m citing here. It’s really going to wreak havoc on markets.

This is all happening at a time when we have robust growth requiring higher rates to keep inflation in check, we’ve printed more money than at any time in history ( and rates are lower than we’ve seen them is many years. As the dollar strengthens and the Fed unwinds its balance sheet, foreign governments will find it more and more expensive to use dollars to hedge, and our bonds will simply become unattractive. The higher cost of hedging reduces the value of the bonds. Imagine buying a car and the insurance on the car costs more than the car is worth. But those governments have to stay liquid and they have to hedge their imports and exports; China will most likely step in to fulfill that role and we’ll begin to see the U.S Dollar get supplanted by the Chinese yuan as the preferred currency of international trade. The U.S has made the transition from the largest creditor nation in history to the largest debtor nation in history. The next century belongs to China.

What Can You Do?

There are a few things you can do t try and prepare for a soft landing or maybe even profit.

In terms of monetary policy, fiscal policy, quantitative easing, sovereign debt, interest rates, geopolitical events and all the rest…nothing, you and I can’t do a damn thing. You are more likely to stop plate tectonics.

In terms of hedging your current financial position to protect yourself, maybe even profit from the situation, there is a lot you can do. Start by buying a lottery ticket.

In my January post I didn’t just talk about bonds and rising rates; I shifted the portfolio and bought shares in the TBT (ProShares UltraShort 20+ Year Treasury). A short is an investment that benefits from an investment that declines in value. In this case, the TBT goes up in price as long term treasuries fall in price.

If you have experience with option trading there are any number of PUT options that can be bought and sold to protect your downside.

There are numerous ETF funds that short treasuries. These are much easier for the average investor to own and are easy to buy and sell online. Some of the most popular are the TBT, TBF, TMV, PST. For good liquidity and expense ratio I prefer the TBT.

  • ProShares Short 20+ Year Treasury (TBF): This inverse ETF seeks to deliver daily results that are equal to -100% of the Barclays Capital U.S. 20+ Year Treasury Index, a benchmark for long-dated Treasuries. Because TBF resets exposure daily, so don’t expect returns to correspond to the inverse of the related benchmark; performance over extended periods of time will depend on the path taken by the bond index. Net asset are about $642 million with an expense ratio of 0.92%.

  • ProShares UltraShort Barclays 20+ Year Treasury (TBT): This fund is similar to TBF, but instead offers -200% leverage on the same index. That means that TBT seeks to deliver daily results that correspond to -200% of the change in the benchmark. TBT has become the largest leveraged ETF on the U.S. market; Net assets currently stand at about $2 billion with an expense ratio of 0.90%.

  • Direxion Daily 20 Year Plus Treasury Bear 3x Shares (TMV): This ETF provides even more leverage, seeking to deliver daily results equal to -300% of the daily return on the NYSE 20 Year Plus Treasury Bond Index. This leveraged ETF could be a powerful tool if the bond bubble begins to deflate. Through 2013-2014 the TMV declined dramatically as bond prices rose and has traded essentially flat until this year. Year-To-Date the TMV is up 19%. Net assets are about $411 million with an expense ratio of 0.90%.

  • ProShares UltraShort 7-10 Year Treasury (PST): This inverse ETF seeks to deliver daily results that are equal to -200% of the ICE U.S. Treasury 7-10 Year Bond Index. PST resets exposure daily. Net assets are about $157 million with an expense ratio of 0.95%.

In addition to these funds you want to look for stocks that will benefit from rising rates and the foreseeable geopolitical environment. China is still a good place to invest and it can be done through stocks and ETF’s that trade on US exchanges. Stocks like NEtEase, YY, JD, Baidu, Alibaba, mobile phone services and makers, and China BioTech. The sectors that should benefit the most would be Financials, Consumer Discretionary and Consumer Staples. Look to manufacturers of appliances, cars, clothes, hotels, restaurants. While Whirlpool has been dead money, I’d start to watch this old stalwart now. Whirlpool may not have to pricing power to overcome steel prices and labor costs, but I still think it's worth watching. Retailer Kohl’s, Costco Wholesale, Home Depot, Dollar General and Casey’s. Oddly industrial's have taken a beating lately but historically they do well in a rising rate environment. Watch Ingersoll-Rand, Illinois Tool works, Paccar, Honeywell, and DowDupont. PayPal, Square, Goldman Sachs, Citibank, Bank of America, JP Morgan top my list for financials. Goldman Sachs may find it's way down to the $210 level before starting a significant climb back up. The other market to hedge against rising rates and the bond market is commodities. Corporate earnings calls have been waving a yellow flag about rising commodities prices for a couple of quarters. I've written extensively about investing in commodities and the sound of the yawns is so loud I'm nearly deaf. I've invested myself in the PowerShares DB Commodity Tracking ETF (DBC) as an easy way to ride rising commodity prices higher. Cycles are very long in this sector so just add to your shares on dips and try to hold about a 10%-20% stake in commodities.

I would also expect to see these companies do well with rising rates; Apple, Microsoft and Caterpillar, while I expect that Proctor & Gamble, Coca-Cola and some of the big healthcare names like Merck and Pfizer will get hit hard.

Keep Me Honest

I am attempting to keep track of my calls and predictions by logging them at the bottom of every post.

  1. Bond prices will decline as a result of rising rates and a Dollar Shortage.

  2. Invest in China stocks. NEtEase, YY, JD, Baidu, Alibaba, mobile phone services and makers, and China BioTech

  3. Invest in Whirlpool (see Whirlpool caveats above), Kohl’s, Costco Wholesale, Home Depot, Dollar General and Casey’s, Ingersoll-Rand, Illinois Tool works, Paccar, Honeywell, and DowDupont, PayPal, Square, Goldman Sachs, Citibank, Bank of America, JP Morgan, DBC, Apple, Microsoft and Caterpillar.

  4. Goldman Sachs slides to around $210/share

  5. Proctor & Gamble, Coca-Cola, Merck and Pfizer will go lower as rates rise.

  6. The Chinese yuan will replace the dollar in international trade. Not this year, but it will happen in coming years.

Stay Invested,

Clay Baker

Disclosure: I am personally invested long in some or all of these funds that appear in the Mother's Little Helper portfolio or manage these investments for my Mother's portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks and funds that do not appear in the MLH portfolio but may be mentioned or related to this article. It is not my intention to advise or encourage the purchase or sale of any security. Since I may on occasion discuss Bitcoin and other cryto currencies I disclose here that I personally own investments in the cryto-currencies listed here: DBC, VTI, VWO, VEA, VIG, XLE, MUB, TBT, GLD, Bitcoin, LiteCoin

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is not intended to offer investing advice, guarantee 100% accurate predictions, or to be interpreted as providing a personal recommendation.

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