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A bear market in bonds does not bode well for the stock market or the economy.

A bear market in bonds does not bode well for the stock market or the economy.

The
fact that Wall Street and the financial media continue putting a positive
spin on the recent rise in long-term interest rates is the best example
I have seen of the extreme level of complacency in the market. Rising
long term interest rates have nothing to do with a strengthening economy.
The meteoric rise and subsequent collapse of bond prices from May 2003
until today is most likely the speculative blow-off top of the bond
bull market which has been ongoing since 1982. This is similar to the
blow-off top experienced in the NASDAQ in late 1999 and early 2000.
If this comparison holds true, bonds are now beginning a major bear
market.

While falling interest rates have been a powerful tailwind for the stock
market and the U.S. economy, rising interest rates will now be an even
more powerful headwind. Rather than signaling future strength in the
economy, the rise in bond yields is in reality a harbinger of severe
economic weakness. An economy that lives on falling interest rates will
certainly die by rising rates.

The real reason interest rates are rising is that foreign savers are
becoming more reluctant to finance the U.S. government’s runaway deficit
spending, irresponsible U.S. corporate borrowing, and the profligacy
of the American consumer. Whatever the reason, if bonds are in a new
long-term bear market, interest rates will be rising for years. Contrary
to the wishful thinking of market pundits, the recent collapse of bond
prices does not signify the end of the rise in long-term interest rates
but the beginning. As I have written many times in the past, the weaker
the U.S. economy gets, the higher interest rates are likely to rise.
That is because a weaker economy will not only lessen the demand for
U.S. financial assets but will simultaneously increase the supply of
those assets as the federal budget deficit widens. Compounding the problem
will be the increasing likelihood that the Federal Reserve will monetize
a greater portion of these growing federal deficits.

The U.S. consumer-driven, credit-financed, economy is completely dependent
on the willingness of foreign producers to lend. Ours is an economy powered
not by production, but consumption, which is in turn supported by foreign
production and access to cheap foreign credit. In fact, close to 50%
of U.S. stock market earnings are now generated by financial services.
Such an economy, while viable with falling interest rates, is much less
so with rising rates. America went down the road of monetizing government
deficit spending in the 1970’s, and arrived at a destination that included
high inflation, recession, a vicious bear market in stocks, high unemployment,
and 20% interest rates. Imagine how much worse these statistics will
become considering that the U.S. is no longer the wealthy, savings rich,
manufacturing, creditor nation it was in the 1970’s.

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