From July 8th to August 19th, the interest rate on the 10-Year Treasury note has moved from 1.35% to 1.58%. On July 10th, I wrote that safety-oriented investments were mispriced. As Jeffrey Gundlach said, it was not prudent to buy 10-year Treasurys at these yields, calling them the “worst trade location”. The overvaluation of “safer” assets was at an extreme level. Over the last month, the Utilities Select Sector SPDR ETF (XLU) has dropped -3.44% and Vanguard REIT ETF (VNQ) is down -2.50%. As rates increased during this period, the S&P 500 ETF (SPY) returned a positive 1.09%.
Many prominent investors continue to sound the alarm on the potential losses that will occur if central banks are forced to act sooner as inflation increases. A few Fed officials this week are signaling that there may be another interest rate increase this year. Even former Federal Reserve Chairman Alan Greenspan believes that interest rates will begin rising soon, perhaps rapidly. “I cannot perceive that we can maintain these levels of interest rates for very much longer,” he told former Securities and Exchange Commission Chairman Arthur Levitt in a Bloomberg Radio interview . He added, “They have to start to move up and when they do, they could move up and surprise us with the degree of rapidity which may occur.”
In a CNBC article this week, Paul Singer’s Elliott Management, which has $28 billion in assets, warns that the bond market is “broken” and that when the central bank actions of recent years no longer ward off a market downturn, the subsequent loss of confidence could be severe. He continued that today’s environment marks “the biggest bond bubble in world history,” and “the global bond market is broken.”
Bond are no longer an asset class that is a “safe haven”, yet many investors are still buying bonds for this reason. Below is a chart of the weekly bond fund flows, and it shows that throughout 2016, investors have been steadily buying bonds.
Source: Yardeni Research, Inc.
It is a very challenging investment environment for retirees or for those planning for retirement. With $13 trillion of the world’s sovereign debt trading below 0%, there is much less of a chance for higher future returns. Prudent asset allocation will be critical to achieve their goals. My concern is that losses in the bond markets will spill over into the equity markets. So far, money has not left the markets but has been rotating into growth stocks. The Nasdaq posted its first 8-week win streak since 2010. This has been a great trend for growth stocks, and I continue to believe that there is more potential for upside.
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