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Why Are Bonds Losing Value?
By: Thomas Mullooly
We know that bond prices, like anything else with a price, can be tracked on a
point and figure chart. We can also monitor the relative strength of bonds, just
like we do with stocks. Also, when bonds in general gave a relative strength
sell signal over two years ago, we knew that this group would likely perform
poorly, when compared with the rest of the overall market.
It’s important to know that a large rise in rates can be just as devastating or
catastrophic as a stock market crash to many investors. Especially investors who
blindly follow computerized asset allocation models.
But WHY is this all happening? And why NOW?
Let’s face it; the Fed has been raising rates for well over a year now! Why
didn’t bonds start collapsing back then?
Could it be there is no confidence in the new Fed Chairman? Could it be a
“proxy” on the current President’s administration? Could it be a resurgence of
inflation? Could it be the ongoing struggle between the dollar and the other
currencies around the world? Could it be the fact we are getting mixed signals
about the economy…where the “man on the street” sees no improvement, but yet,
economists see signs things are picking up?
Maybe it is a combination of all of these reasons!
Perhaps it is something so very simple and basic that market pundits just keep
missing it!
Maybe it is simply the fact that more people are selling bonds than buying
bonds, which pushes prices down.
Look, when too many sellers appear, in any market, prices must fall. That is
true whether you are selling fruit on the corner, selling all your baseball
cards on Ebay…or if you are selling bonds.
But…most importantly, it DOES NOT MATTER why bond prices are falling and
interest rates are climbing. I’ll say that again, it DOES NOT MATTER what the
reason is for these price changes.
What matters is what you will need to do about it.
You see, the bond market, compared to the stock market, can sometimes be like
the Wild West. The stock market has trading collars and curbs put in place since
1987 to avoid meltdowns like we saw on October 19th, 1987. The bond market has
no such limitations. And don’t forget, there are no stop orders or limit orders
to help dry up the outstanding demand or supply.
It’s a lot like that scene at the end of the movie “Trading Places” when Dan
Ackroyd and Eddie Murphy are trading futures on frozen concentrate orange juice.
When everyone wants to sell, it becomes frenzy…with no end in sight. With little
or no stability in prices.
A lot of people just don’t understand this! Selling a bond can be like selling
your home. When you want to sell a bond, there is rarely a “listed” market. So
you need to contact a broker. They will come up with an offer price to buy your
bond from you. This price has to work for you, or you won’t sell. But it also
has to work for them…they will often turn around quickly and offer it elsewhere,
in an effort to make a profitable trade.
There are times when firms will not want to buy a bond that is being offered
around by another broker. So they will enter an extremely low offer to buy the
bond, not a serious offer. But when a firm really needs to unload a particular
bond, it has to take these bids, just to move a bond. So, once the word is out
that XYZ’s bonds just traded at a severe discount, all bonds of that issue will
often begin to slide as well. This is how chaos begins in bond markets.
The moves can be sudden, and they can be violent…both up and down!
It’s been a while since the bond market has experienced some real volatility.
Hopefully we will not experience that, but we need to be prepared for the chance
that we might.
About the Author:
Thomas Mullooly, President of Mullooly Asset Management, works one on one with
individuals so they can regain control of their investments. Tom's popular email
alerts help folks to reduce the risks in their portfolios. To learn how to stop
making simple investing mistakes and to sign up for Tom's email alerts, visit
http://www.mullooly.net, today! |
