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The Great Interest Rate Explosion of 2010-2011 How to Protect Your Wealth and Profit

Interest-Rates / US Bonds May 03, 2010 - 10:22 AM GMT

By: Mike_Larson


Diamond Rated - Best Financial Markets Analysis ArticleThe dot-com bubble of the late 1990s. The housing bubble of the mid-2000s. They both wreaked massive havoc on investor portfolios. Trillions were lost … both here and abroad.

At Weiss Research, we take pride in the fact we warned of the epic destruction well in ADVANCE of the twin busts in tech stocks and housing.

Martin and his colleagues coined the term “dot-bombs” in the late 1990s. And I urged investors to dump every last real estate investment they owned long before home prices crashed.

Now, a NEW massive bubble is starting to burst. Now, a grave new threat is staring you in the face. And now, I believe those who ignore our warnings will once again be sorry. That bubble? The Treasury bond market!

This is no small backwoods corner of the financial world. Quite the contrary, the bond market is enormous. As of year-end 2009, there were $34.7 trillion of U.S. government, corporate, municipal, and other bonds outstanding. By comparison, the entire market capitalization of the broad Wilshire 5000 Total Market Index for stocks is just $13.9 trillion.

Translation: The U.S. bond market is two-and-a-half-times the size of the U.S. stock market! Among the categories of bonds outstanding, the U.S. has $2.8 trillion of municipal securities and $2.4 trillion of bonds backed by credit cards, auto loans and similar assets.

But the biggest sector of the bond market is, by far, U.S. Treasury securities. Marketable Treasury bills, notes, and bonds outstanding (which excludes those held in certain government trust funds and accounts, as well as those at the Federal Reserve) totaled $7.6 trillion

Each and every day, Washington is sowing the seeds of our nation’s NEXT financial disaster … and one of the biggest threats to your wealth that’s looming in 2010-2011 — a crash in the U.S. bond market. And, since exploding long-term interest rates are simply the mirror image of crashing bond prices, the interest rate explosion is equally inevitable.

The Treasury Department and Federal Reserve are driving us inexorably in that direction with every inflation-fueling promise of free money … every budget-busting bailout … and every multi-billion dollar bond auction. Our foreign creditors are growing more disgusted, and the day of reckoning is rapidly approaching.

Yes, investors may SAY they see higher interest rates ahead. But their ACTIONS tell us they’re mostly oblivious to the dangers. Most seem to think bonds are bulletproof — a much safer alternative to equities.

Unfortunately, the cold, hard truth is that bonds can sometimes plunge in value just as much as stocks. And that’s not just true for high-yield, or “junk,” bonds. It’s also the case with medium- and long-term Treasuries! Consider these three historical examples:

  • Between June 1979 and February 1980, the price of 30-year Treasury bonds fell from about 92 to 62. That’s a decline of almost 30 points. In other words, long-term Treasuries lost almost one-third of their value in just eight months! Bond yields, which always rise when bond prices fall, shot up from 8.9 percent to 12.6 percent.
  • Or consider the bond market collapse from September 1993 to November 1994. Bonds tanked from around 122 to 96. Total loss? More than 21 percent in just over a year. Rates surged from 5.9 percent to 8.13 percent.
  • And if you think all that’s ancient history, look at the price collapse that began much more recently. Treasury bonds plunged 30 points between December 2008 and June 2009. Interest rates almost DOUBLED — from 2.5 percent to 4.8 percent. And those declines could be child’s play compared to the bond market plunge I see coming very soon.

The Threat Is Here; The Time to Act Is Now

All this leaves you with two choices:

1) You can ignore the warning signs just as they are doing in Washington. You can assume our nation’s credit card will never be declined. You can just go on hoping for the best, while NOT preparing for the worst.

2) Or you can act now, with diligence and foresight, to avoid this disaster in the making. You can build a protective wall around your portfolio. And you can go on the offense, turning this looming disaster into one of the greatest profit opportunities of a generation.

My opinion? If you’re not paying attention to this new phase of the debt crisis, you’re making a grave error. And if you’re not taking swift action to protect yourself, you’re taking your financial life in your hands.

In this report, I will not only show you why the Great Interest Rate Explosion of 2010-2011 is going to get worse, why the Federal Reserve is powerless to stop it, and how it will impact investors and the capital markets overall but …

I will also show you what you can do right now — TODAY — to protect yourself and your family from the inevitable fallout. Best of all, I’ll tell you how to turn lemons into lemonade using my powerful, three-pronged profit strategy.

How High Long-Term Interest Rates Might Go

I don’t expect an exact replay of the disastrous bond bear market in the early 1980s. But I can’t rule it out, either. I foresee three possible scenarios, all of which are bad for bondholders …

SCENARIO #1: If interest rates simply return to pre-crisis levels (circa 2001), I calculate that the yield of the current 30-year Treasury bond could rise to the 5 2/3-6 percent range. Assuming 5.86 percent, that would mean a price decline of 16.7 percent from today’s levels.

What might provoke this kind of move? The forces outlined above. But I don’t believe we’ll stop there …

SCENARIO #2: In a more likely scenario, I see bond yields breaking through a key resistance level at 4.81 percent and surging to a target range of roughly 7¼-7½ percent. Assuming 7.36 percent for 30-year T-bond yields, we’d see a bond price decline of about 32.3 percent.

The same forces above would help launch this kind of move. Then it would gather steam as large foreign bondholders like Japan and China joined in the selling. Add in a major rise in U.S. sovereign debt fears, and it’d be a recipe for disaster.

SCENARIO #3: This scenario is possible but would require one more major element that I am not assuming in Scenarios #1 and #2 — the return of double-digit inflation. I am not counting on this additional boost to interest rates and nor should you.

But if it happens, there’s virtually no limit to how high interest rates could soar. With CPI inflation of, say 12 percent or more, the price of the 30-year Treasury bond could be decimated, sending its yield soaring to 14 percent or even 15 percent.

Fortunately, you don’t have to sit idly by while your fixed income portfolio is destroyed. You can take immediate action to avoid the carnage.

Step #1 Find out if you have a problem!

By now, you’re probably wondering how to suck out the poison in your fixed income portfolio. The good news? For mutual funds and exchange traded funds, it’s pretty easy. Your fund sponsor will gladly provide you with two key statistics: “weighted average maturity” and “average duration.” (These figures can also be found online.)

The maturity figure tells you how long the bonds in the fund will take to close out, or mature. It’s expressed in terms of years, such as 4.5. The figure is further adjusted to account for the dollar sizes of each bond position.

Duration is another useful statistic. It’s a rough measure of how much a fund will decline in price for every percentage point rise in interest rates. For instance, a duration reading of 10 years means a fund will lose roughly 10 percent of its value if rates rise by 1 percentage point.

The higher the weighted average maturity of a fund, and the higher its duration, the riskier it is. So get these critical numbers and scrub your fixed income portfolio!

What about individual bonds? Perform the same exercise. Figure out how long your security has until maturity. The same rule that applies to mutual funds and ETFs applies to individual Treasury bonds, municipal bonds or corporate bonds, whether investment grade or junk: The farther out the maturity date, the more you stand to lose if rates surge.

10 Vulnerable Bond Mutual Funds in Great interest Rate Explosion of 2010-2011Step #2 Dump the dead weight!

Don’t get caught up focusing on the income stream your fixed income investment is throwing off. Don’t fall victim to the misguided thinking that as long as you just hold your bond to maturity, you aren’t losing money.

Technically, yes, a loss isn’t booked until you sell. But you can’t forget about opportunity cost! Think of what you could be doing with the money you have locked up in a bond that’s losing value. My advice: Apply the same thinking to your bonds that you do to your stocks.

For example, if you had a very strong feeling a stock was going from $20 to $10, would you just hold your 100 shares and let it happen? Or would you sell, sidestep the decline, then scoop up TWICE as many shares at the cheaper price — something that would magnify your profits down the road when the price rebounded?

Of course you’d do the latter. And that’s what you should do with your bonds. You can sell when, say, interest rates on 30-year bonds are 5 percent … keep that money in cash and sidestep the price decline … then swoop in and buy NEW bonds yielding 7 percent, 8 percent, or more!

My advice? If the average maturity of your ETF, mutual fund, or individual bond is greater than about two years, don’t wait around — sell. Fortunately these days, with nearly all bond funds and most bonds, you can sell at the market, with no hesitation. However, with some thinly traded corporate or municipal bonds, you may need to give your broker some leeway — to work your order at a more favorable price. Either way, get out as soon as you can!

To help you with the purging process, I’ve included in this report a list of 10 government bond mutual funds with some of the highest weighted average maturities and highest durations. These are among the most vulnerable funds in an environment of rising long-term interest rates.

10 Vulnerable Bond ETFs in Great interest Rate Explosion of 2010-2011I also give you a list of some of the 10 most vulnerable bond ETFs, each of which should get hammered as bonds decline in value. If you own any of these mutual funds or ETFs, I recommend you sell without delay!

What should you do with the money you pull out of these vulnerable investments? Park it in short-term Treasuries, such as 3-month or 6-month bills. Those very short-term securities suffer virtually zero price declines even when interest rates explode higher.

You can buy Treasury bills straight from Uncle Sam via the Treasury Direct program ( or 800-722-2678). Or you can purchase them through your broker.

Another option? Treasury-only money funds. You can find a list of funds here.

Step #3Turn Rising Rates Into a Potential Profit Goldmine!

If you’re a conservative investor, the easiest way to escape the brutal grip of higher interest rates is to just sell your bonds and park that money in short-term Treasuries.

But what if you’re a more aggressive investor?

What if you’re the kind of investor who likes to go on the offense?

What if you want to turn rising rates into a potential profit goldmine?

Then I have good news for you. You don’t have to be an investing “whale” any more. You don’t have to be some hot-shot hedge fund trader, or the manager of some multi-billion dollar mutual fund.

You — the individual investor — now have several easy ways to convert a Treasury bond market collapse … and a surge in interest rates … into a huge profit opportunity!

Profit Tool #1: Shorting Bond ETFs

You’re probably familiar with traditional ETFs. They buy a basket of stocks, allowing you to profit from moves in individual sectors … the overall S&P 500 … or even several overseas markets.

ETFs are great because they cost less to own than many mutual funds. They don’t nick you for loads of 12-b1 (marketing) fees. They’re priced continuously throughout the trading day, and you can trade them using all kinds of useful strategies, like pre-set stop-loss and grab-profit orders.

But you may NOT know that bond market ETFs have been proliferating like crazy. Just like stock ETFs, they own a basket of investments — but those investments are bonds, not equities.

A few examples: The iShares Barclays 20+ Year Treasury Bond Fund (TLT) invests in longer-term U.S. Treasuries, while the iShares 10+ Year Credit Bond Fund (CLY) buys longer-term investment grade U.S. corporate bonds and dollar-denominated bonds issued by foreign governments and other entities. Other long-term bond ETFs include the Vanguard Extended Duration Treasury ETF (EDV) and the Market Vectors High Yield Municipal Index ETF (HYD), with investments in Treasury “strips” and longer-term municipal bonds, respectively.

When you buy one of these ETFs, you make money from a rise in its price. If you want to profit from a DECLINE, however, you can “sell short” the ETF in question. In a short sale, you borrow shares, sell them, then hope for a price decline so you can repurchase the shares at a lower price.

The short-selling strategy can be risky, though. If the price of the ETF you’re targeting rises, you’ll lose money. You will also need special approval from your broker and a margin account to sell short a bond ETF. Moreover, you can’t sell short bond ETFs in a tax-privileged account, such as an IRA.

So how do you get around those problems?

Profit Tool #2: Inverse Bond ETFs

Over the past couple of years, an increasing number of INVERSE bond ETFs have hit the markets. These ETFs are designed to RISE in value when the targeted investment falls in price (or in the case of bonds, when interest rates rise.)

In my view, they are a great tool to profit from falling long-term bond prices and rising interest rates. You don’t need a margin account — and purchasing one of these ETFs is just like purchasing any other ETF.

Three inverse bond ETFs in particularly target the longest-term part of the bond market — the portion I believe is the most vulnerable …

  • ProShares Short 20+ Year Treasury (TBF) — This inverse ETF is unleveraged. It’s designed to rise 1 percent for every 1 percent decline in the Barclays Capital 20+ Year U.S. Treasury Bond Index, a benchmark index that tracks long bond prices. The TBF has been around since August 2009 and features an expense ratio of 0.95 percent.
  • ProShares UltraShort 20+ Year Treasury (TBT) — This inverse ETF is leveraged. It’s designed to rise 2 percent for every 1 percent decline in the same index listed above. ProShares introduced this ETF in May 2008 and it features an expense ratio of 0.95 percent. Unlike some leveraged ETFs, it has also done a fairly good job of tracking its benchmark over both the short term AND long term.
  • Direxion Daily 30-Year Treasury Bear 3X (TMV) — This inverse ETF is even more leveraged. It’s designed to rise 3 percent for every 1 percent decline in the NYSE Arca Current 30-Year U.S. Treasury Index. That index tracks the price performance of the most recently issued 30-year Treasury Bond. Direxion rolled this ETF out in April 2009 and it features the same expense ratio as the other two ETFs listed here.

Inverse bond ETFs aren’t without risk, of course. If bond prices rise, and interest rates fall, the value of these ETFs will go down. Your losses will be magnified if you opt for the leveraged route (meaning, TBT or TMV over TBF). But if your timing is good, you could rack up substantial profits in any or all of these instruments.

Profit Tool #3: Inverse Mutual Funds, Futures, and Futures Options

ETFs aren’t you’re only investment choice, either. You can also buy mutual funds that trade inversely to portions of the bond market.

For instance, the Rydex Inverse Government Long Bond Strategy Fund (RYJUX) is an unleveraged mutual fund that rises in value as bond prices fall. It features an expense ratio of 1.41 percent. Meanwhile, the Access Flex Bear High Yield Fund (AFBIX) is designed to move in the opposite direction of the price of high yield (junk) bonds.

If you’re comfortable trading futures, you can instead use instruments that change hands on the Chicago Board of Trade. The CBOT has a “long bond” futures contract that reflects the price performance of bonds with maturities of at least 15 years. It also just rolled out “Ultra” long-term bond futures that reference bonds with maturities of at least 25 years.

You could sell short a futures contract, or purchase put options on the long bond futures, to profit from falling bond prices. Each option represents the right — but not the obligation — to sell one Treasury bond future with a face value of $100,000 at maturity. The value of that right will increase as the price of the underlying futures contract falls.

Warning: Futures and future options are strictly for experienced traders familiar with the risks and potentially unlimited exposure.

Other Eventual Consequences of Rising Long-Term Interest Rates

For now and the intermediate-term future, the primary consequence of rising rates will be falling bond prices. Rates haven’t risen far enough, fast enough to get the stock market’s attention. The improvement in the global economy is also offsetting the impact of higher financing costs.

Result: I do not advocate shorting the broad stock market yet strictly because of higher rates. I would rather you DIRECTLY profit from that rise using the DIRECT investments I mentioned earlier.

But later in the cycle, rising rates will matter. They will be pure poison for:

  • The nation’s insurance companies, which are loaded with long-term corporate and government bonds.
  • The nation’s banks, which are counting on low interest rates to raise funds for close to nothing.
  • The nation’s utilities, which must continually borrow huge amounts of long-term money to finance their massive investments in power plants and facilities.
  • The nation’s home builders, which are relying on cheap financing and Uncle Sam’s largesse to keep buyers coming in their front doors.
  • The nation’s high-yielding REITs, which directly compete with bonds for fixed-income money. If yields on less-risky Treasuries rise, the value of Real Estate Investment Trusts will fall. Financing costs for commercial real estate projects will also climb.

Plus, interest rates are major factors in the ups and downs of other markets as well.

  • Foreign countries where interest rates are rising sooner and faster than in the U.S. can enjoy a major boost to the value of their CURRENCIES.
  • Inflation and inflation fears, which almost invariably drive interest rates higher, also drive up the value of COMMODITIES.
  • Virtually every nation, market and sector is impacted by interest rates — sometimes positively, sometimes negatively. So knowing when and how interest rates will move gives you a MAJOR strategic advantage with almost every investment on the planet.

Don’t Forget the Impact on Your Personal Finances!

Most of this report is dedicated to the INVESTMENT consequences of rising long-term interest rates. But you can’t forget the impact of rising long-term interest rates on your personal finances, either.

For starters, long-term mortgage rates tend to track long-term Treasury yields. If yields rise on 10-year and 30-year Treasury notes and bonds, they’ll also climb on 30-year fixed-rate mortgages.

For most of 2009 and early 2010, 30-year mortgage rates fluctuated on either side of 5.25 percent. I expect them to head to the mid-to-high-6 percent area as a result of the bond market crash.

Rates on longer-term corporate loans, car loans, and fixed-rate home equity loans also tend to track longer-term Treasury yields. So you can expect those kinds of loans to cost more as Treasury-bond rates explode higher.

Variable rate home equity lines of credit, shorter-term business loans, and credit cards are not directly impacted by the rise in long-term rates. That’s because they usually track the London Interbank Offered Rate (LIBOR) or the prime rate; and these closely follow the very short-term federal funds rate controlled by the Federal Reserve.

But as time passes, the Fed will be forced to “follow” the bond market. It won’t be able to keep the fed funds rate pegged near zero percent. It will have to raise rates — whether it wants to or not — in order to show it’s trying to tamp down inflation and to reassure fleeing bond investors that it’s not going to let the value of their money collapse. When that happens, rates on these other kinds of loans will rise.

So what can you do to protect yourself?

  1. Lock in the longest-term mortgage you can get now if you’re buying a house or refinancing your existing loan. A rate of 5 percent and change is much better than you’re going to get six, 12 or 18 months down the road, in my view. Pay down or close any home equity line of credit you have — and work at paying off credit card debt. The interest costs on those debts are going to go up when the Fed is forced from the sidelines.
  2. Many banks also allow you to fix the rate on a portion of your home equity line of credit balance for a fee. Check to see if you have that option and if so, take advantage of it. The same would go for any business loans you may have outstanding.

By taking all of these steps — with your fixed income portfolio AND your personal finances — you will be prepared for the world that’s coming. A world where cheap, easy money is a thing of the past. A world dominated by The Great Interest Rate Explosion of 2010-2011.

Best wishes,


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