“Taper Tantrum” Triggers Bond Exodus

Todays top stocks to buy“Signs of an improving economy are leading to record bond-fund redemptions and dragging fixed income securities into a bear market.  Here’s what’s happening and a top stock pick to protect your portfolio” —

It’s happening just like I called it several months ago.

The mere mention of the word, “tapering” is sending shockwaves through the markets.

It started when Federal Reserve Chairman Ben Bernanke announced that he would consider “tapering” off the Fed’s $85 billion monthly bond purchases on signs of an encouraging economic recovery. And just such signs have recently have started to show…

  • New home sales are returning to levels not seen since before the recession.
  • At least 195,000 new non-farm jobs were added for three consecutive months, which is nearing the Fed’s magic number of 200,000 per month.
  • The US manufacturing sector expanded for five of the last six months.
  • Orders to US factories have risen for three consecutive months.
  • Consumer sentiment in the US is at a six-year highs.

In other words, with growing confidence in the US economy, the Fed believes they can soon begin to roll back on their unprecedented stimulus efforts.

Folks, this a big red flag for rising interest rates on the horizon. And not surprisingly, reaction from bondholders has been spectacular… but not in a good way.

Within a week following Bernanke’s June 19th statement, bond funds that benefited from a $1.26 trillion injection over the last 6 years suddenly saw a sell-off of $61.7 billion.

Over the past few weeks, we’ve seen the benchmark 10-year Treasury yields soar.  As of Friday, it’s risen to its highest level in two years.

If the withdrawals keep at that pace, the $1.26 trillion that investors plowed into the bond market could be effectively wiped out in as little as 20 weeks. This, of course, is a worst-case scenario, but nonetheless, the bears believe the bleeding has only just begun.

Should the economy continue on its trajectory, the Federal Reserve estimates it could start scaling back their asset purchases as early as later this year.

So what are bond investors to do?

Bond King Bill Gross doesn’t necessarily think it’s time to abandon ship – especially in the medium term. Here’s why:

  1. He thinks the Fed’s forecast of the economy which prompted “tapering” panic is far too optimistic.
  2. Inflation, according to the Fed’s own statistics is running close to a 1% pace – far below their target of 2.5%, meaning there’s room to inflate.
  3. Yields have adjusted by too much.  Even after QE, the Fed has stated that the Fed Funds rate likely will not increase for a substantial period of time.  Gross predicts until at least mid-2015 and even then subject to a consistently strong economy that produces 2%+ inflation.

His conclusion, the bond market ship is not sinking.  But expect low but positive returns in future years.

What’s my take?

I’m a huge fan of Bill Gross and have deep respect for his market insights. But I’ve always had an equity bias (I’m not a big bond trader) because over the long term, history has shown stocks outperform bonds.

Furthermore, the famous Warren Buffett has even gone on the record as saying bonds are terrible investments now:

“The price of everything determines its attractiveness… Bonds are priced artificially. You’ve got some guy buying $85 billion a month. And that will change at some point, and when that changes people could lose a lot of money if they’re in long term bonds…

Someday [bonds] will yield a lot more than they do now. I don’t know when that will happen. It’s going to happen, the question is always when… [and] to what degree it happens. You could have interest rates very significantly different than what they are now in some reasonable period in the future… It will happen.”

Down the road, perhaps, bonds could once again become attractive vehicles as rates stabilize.

But it could be years before that happens, and I’m not holding my breath.

Instead, I’m doing as I’ve always done – look for promising companies with great potential.  Over the long term, I’m confident stocks will always be where you want to be.

And with that said, where should you put your money? There are plenty of options, but here is today’s top stock pick…

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John Holt
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