Thoughts from Jim Puplava's recent Big Picture podcast, "The Next Crisis – It's Not What You Think," which can be listened to in full on the Newshour podcast page here or on iTunes here.
In the age of zero interest rates, many investors have been forced to find yield wherever they can. For many this leads to investing in high yield bonds. But many investors do not read the fine print, so to speak, when buying bond mutual funds that contain riskier securities.
In his most recent Big Picture podcast, Jim repeats his warnings from earlier this year (see here) of coming risks to the bond market, both in terms of interest rate risk and liquidity risk.
Given that bonds have been in a near 35 year bull market, few people alive today have experienced a bear market in bonds. This is all the more reason for investors to take notice of the possibility that what no one expects—namely falling bond prices—may be a real possibility.
Jim begins by explaining how one big problem tied to many parts of the bond market is growing lack of liquidity. Jim explains how this problem has its origins in well-intentioned government regulations to make sure banks have higher capital ratios, which is not a bad thing, except that it has caused many dealers to exit the market.
Legendary investors like Carl Icahn and Jeff Gundlach have also been quite public in warning about the high yield “junk” bond market and the severe losses that unsuspecting investors may face ahead (see here and here). Unfortunately, as with the subprime boom, Wall Street has no problem packaging up bad investments as safe and then unloading them on investors.
Jim points to what he calls “tremors in the bond market” as a portent of things to come. A good example was the taper tantrum of mid-2013, where bond fund investors experienced double-digit losses when Treasury yields briefly doubled. Jim repeats his warning that at some point the Fed will be forced to raise rates, as the economy improves or inflation moves higher.
However, given that so many unsophisticated investors have unwittingly piled into bond funds, they are more likely than ever to get spooked by the first signs of trouble in a rising rate environment. Since investors tend to act like a herd, once panic starts fund managers will be forced to sell whatever they can—and likely at unattractive prices for other investors.
For these reasons and others, Jim explains that his firm avoids junk bonds. And even though many lower quality bond funds are already off 20% or more from their 2014 highs, he counsels investors to examine their holdings carefully to know both the potential risks and rewards of each position.
When asked about times and dates for the coming bond market crisis, echoing “bond king” Jeff Gundlach, Jim feels it may take two or three years before the downstream effects of Fed interest rate increases (which have yet to begin) impact the market. But eventually, as the saying goes, the Fed will raise interest rates until something breaks.
Listen to this full broadcast with Jim Puplava, President and Chief Investment Strategist at PFS Group, by clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.
