Michael Lombardi: In May, the bond market suffered the biggest monthly sell-off since 2004. (Source: Bloomberg, June 3, 2013.) To gauge the extent of the selling, take a look at the chart below, which shows the yield on a 30-year U.S. Treasury.
From the first trading day of May to the last trading day of the month, the yield on a 30-year U.S. bond increased more than 17%—soaring from 2.81% to above 3.3%. This move is significant for the bond market, because as the yields on bonds rise, the prices of bonds fall.
Chart courtesy of www.StockCharts.com
What does this mean? Traditionally, rising bond yields indicate inflation ahead, something I have been warning about. But if I had to bet, I would say investors have tired on the low yields of bonds and are moving into higher-risk investments, such as the stock market.
What we already know is that as the yields on the U.S. bonds declined, bond investors moved from the security of U.S. government bonds into higher-yielding bonds—those that are higher-risk and are often considered speculative by credit rating agencies.
We can see the move to higher-risk bonds in the number of new non-government bond issues. In the first four months of this year, $115.1 billion worth of high-yield U.S. corporate bonds were issued. (Source: Securities Industry and Financial Markets Association, May 14, 2013.) In 2012, $329.2 billion worth of high-yield debt was issued in the bond market, and in 2011, this number was $224.1 billion. That adds up to $670 billion in corporate bonds in 28 months!
Taking all this into consideration, as the yield on 30-year U.S. bonds moves higher, the yield on corporate bonds in the bond market will rise further and bond prices will go lower—that means bond investors will take a loss if they sell early! And, of course, they will sell early as few investors actually hold long-term bonds until maturity.
According to Lipper Data, high-yield bond funds in the U.S. witnessed withdrawals of $875 million in the week ended May 31. This was the biggest outflow from these types of funds since February. (Source: Bloomberg, May 31, 2013.)
Bond investors need to practice extreme caution, because the dynamics of the bond market have changed. The most basic indicator of the bond market, the 30-year U.S. Treasury, is showing weakness ahead. If this continues further, it will result in an even steeper sell-off throughout the bond market.
Dear reader, when the yields in the bond market fall, bond investors face severe losses. I wouldn’t rule out a mass exodus from the bond market.
This article is brought to you courtesy of Michael Lombardi from Profit Confidential.
Related: iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT), ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT).