The Only Way Bond Yields Will "Go Up" Now

Last week the Fed again lowered its economic forecast for the United States to 1.8% to 2.0% (from 2.0% to 2.3%).

While the Fed doesn't want to connect the dots for you, I will be happy to do so.

This slow growth is the inevitable result of too much debt, too much regulation, too many new entitlements like Obamacare, and a total absence of meaningful fiscal policy such as tax reform. We are governed by a confederacy of dunces at the Fed and in Congress and the White House, and they are leading us straight into the jaws of another financial crisis - or Super Crash.

This means that growth will be slow for years to come, and interest rates will remain suppressed. In fact, that is Super Crash Inevitability No. 2: The global economy is stuck with subpar growth.

When it comes to the assets and investments you may hold, this has an especially nasty effect on  bond yields.

It will continue to render traditional bond investments unattractive because they will continue to offer extremely low yield. All you have to do is look at the returns being generated by even the most highly respected bond managers in the world and the largest bond funds in the world to realize that you will go hungry depending on bonds for income and total returns.

There is one way bond yields will "go up"... but it's not good.

When Will Bond Yields Go Back Up?

Bonds had already been turned into "certificates of confiscation" by the U.S. Federal Reserve before it once again refused to raise interest rates by a miniscule 25 basis points last week.

The question that now must be asked is whether the confiscation of capital from savers will be permanent.

As I showed you last week, there is now little prospect of any meaningful rate increases before 2017. The reason given by Fed Chairwoman Janet Yellen for postponing once again a measly 25-basis-point rate hike - which would have been the first in nine years - was that she was concerned about economic weakness in China and other emerging markets.

And well she should be.

bond yields
China's economy is a house of cards built on a foundation of $28 trillion of debt (as of mid-2014 - it is undoubtedly higher now) that can never be repaid. China's growth is slowing significantly, and whatever growth remains is being driven by government stimulus and debt. China's efforts to generate domestic growth will take time. In the meantime, it has built up an unsustainable mountain of debt.

And the rest of the emerging markets are also suffering from big problems. Brazil is experiencing a major political scandal involving deep corruption at Petroleo Brasileiro SA (NYSE: PBR), which is partly owned by the government. Brazilian President Dilma Rousseff is facing growing talk of impeachment. Russia's economy is in a deep recession as a result of the collapse in oil prices.

Emerging markets borrowed trillions of dollar-denominated debt that became much harder to repay as the dollar appreciated sharply beginning in 2014. The strong dollar was likely another factor that led the Fed to back off from raising rates last week. But doing so only treated the symptoms of the underlying disease - high debt levels and low levels of organic economic growth throughout the world.

There is little prospect of a recovery in any of these foreign economies in the months ahead. The International Monetary Fund projects growth of 3.3% in 2015, revised down from 3.8% a year ago. There are many reasons for this. Japan has failed to address the rigidities that keep its economy stuck in the mud. China, Brazil, Turkey, and other emerging markets appear to have reached the limits of their ability to grow under current policies.

[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]

Since the financial crisis, the average benchmark interest rate set by central banks has been lowered by 4 percentage points in developed markets and 2 points in emerging markets. In addition, central banks have bought bonds and other assets equal to 10% of global output. Yet all of these Herculean efforts have failed to stimulate sustainable economic growth. Why in the world would anyone think that they will suddenly start doing so now? (And here is Super Crash Inevitability No. 4: Central Banks won't be able to rescue us next time.)

The only way bonds will do well is if the economy totally falls off a cliff and interest rates retest their lows of last year. This is a real possibility but not one that would produce particularly exciting returns either. The way bond math works, the returns on a drop in the 10-year yield to 1.5% from current levels are relatively unexciting compared to the potential losses if yields increase to 3.0%.

Do not despair, however. There are always places to earn a good risk-adjusted yield if you know where to look. And after doing this for more than 25 years, I know where to look and want to share my experience with you.

These MREITs Are Misunderstood - and "On Sale"

For example, there are some mortgage real estate investment trusts (REITs) that are trading at sharp discounts to their net asset value and paying double-digit dividends. They are misunderstood by the market, which continues to believe that the Fed is going to start aggressively raising interest rates when it is clear that it is going to do nothing of the kind.

I recommend the following investments as good ways to earn high yields in the current market. The high dividends will provide a cushion against any share price erosion, and these investments should provide an excellent place to invest some cash in the months ahead.

Annaly Capital Management Inc. (NYSE: NLY) $10.55 $9.17-11.65 11.6% 20% discount
Chimera Investment Corp. (NYSE: CIM) $14.54 $11.92-17.05 13.3% 13% discount
Ellington Financial LLC (NYSE: EFC) $18.27 $17.00-23.00 14.3% 22% discount
PennyMac Mortgage Investment Trust (NYSE: PMT) $16.31 $14.68-23.08 15.3% 20% discount

It's Not Good for Most Stocks, Though

Unfortunately, the thesis that ugly bond returns are going to continue to make stocks "the only game in town" isn't going to mean that stocks are going to perform well either.

Major parts of the market have already experienced a stealth bear market with losses of 20% or more. But the same negative economic outlook that suggests that rates will stay low for longer also means that stocks should continue to struggle in the months ahead.

You see, it turns out that the Fed hasn't only destroyed bonds as investments. After pumping up stock prices with funny money for six years, they are now threatening stock prices. As I have been warning since January, when I predicted that the S&P 500 would end the year at 1,875 to 1,900 (down 10%), investors should be hedged against the conspiracy of fools known as the Federal Reserve.

More on that soon.

Follow us on Twitter @moneymorning.

About the Author

Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

Read full bio