For the best browsing experience on this site, we recommend you upgrade your browser
AboutSubscribe Your Editors Contact Us RSS

What the Bond Sell-Off Means for Stocks

Gold, stocks, bonds — all the major markets seem to have turned around in the last six months. Bond investors have been the worst hit. Many have losses of 20% or more. Surely, there are some major financial problems hidden beneath these figures. Sooner or later, they will show up in the headlines…with the announcement of bankruptcies and defaults.

When bonds fall in price, interest charges go up. They quickly squeeze profit margins…and push some highly-leveraged firms over the edge. Readers should be aware that most of the increase in earnings — used to justify higher stock prices — came from the financial sector.

They were artificial and unsustainable profits arising from the Fed’s manipulations. Most likely, financial firms borrowed super cheap money…and played the long side of the stock market.

But now, with debt costs rising…and the stock market rolling over (at least, that’s how it appears to us)…the financial sector is likely to take some hits. Watch out.

Rising bond yields almost automatically cause stocks to fall. Because the capital value of a stream of income (such as dividends or earnings) goes down as the earnings you can get from a ‘risk free’ Treasury bill go up.

The math is simple enough. If you have a business that pays you $100 a year…and T-bills yield 5%…you’d need $2,000 in T-bills to earn the same amount. But if yields rose to 10%, you’d only need half as much. In effect, the capital value of your income stream has been cut in half.

But let’s turn our attention to something else — national defence.

Government’, as William Godwin put in his Enquiry Concerning Political Justice, ‘can have no more than two legitimate purposes: the suppression of injustice against individuals and the common defence against external invasion.

But that was many years ago. Since then government has enjoyed a substantial amount of ‘mission creep’. It now promises everything — from roach control to better dentistry. For a politician, there’s no use in hewing to a strict interpretation of the Constitution or in admitting that the feds can’t really multiply loaves and fishes. Honest modesty will get him nowhere.

 Better to promise to smite the infidels and provide free cable TV. After all, if he doesn’t win the election he can’t carry out his real program, which is the same for all candidates — personal aggrandisement at others’ expense.

But when it comes to mission creep, perhaps no department has crept further than the military; it has slithered around so far that it now menaces the security of the American people. The Pentagon man is no different from the deliveryman or the confidence man. His goal in life it to boost himself up by whatever means are at his disposal.

Unlike the poor deliveryman or even the confidence man, whose prospects are quite limited, the Pentagon man has the bogeyman on his side. Whenever the flow of power and loot slows, he pulls out the threat of invasion…like a burglar pulling out his pistol.

This he waves in front of the public…inspiring fear and loathing. The good man sees his mother raped before his eyes by a horde of foreigners. The bad man merely loathes the foreigner; he cannot abide the idea of the outsider getting away with something.

Soon, they are all approving plans to transfer more of the nation’s wealth and treasure to the men in uniform…and those who supply them.

The fear of invasion seems quaint and anachronistic, hardly necessary in today’s world. What external power is going to mount an amphibious assault on the United States of America? Who’s going to send drones against Washington? What foreign power will set up a military base in Texas or Oregon?

But with no real fear of invasion, what’s the Pentagon to do? Invade someone else! The US maintains bases in some 170 countries around the world. Nobody knows exactly how many…or where they are. Some are secret. Congressman Ron Paul once tried to add them up…even he couldn’t get a straight answer.

Yes, dear reader, times have changed. But humans have not. Give them the opportunity, and they will turn into zombies. The late colonel John Boyd, of the US Air Force, observed that:

It is not true the Pentagon has no strategy. It has a strategy, and once you understand what that strategy is, everything the Pentagon does makes sense. The strategy is, don’t interrupt the money flow, add to it.

Boyd was a strategist. He observed that wars were won by lean and agile fighters…who were able to improvise and innovate quickly as needs and opportunities arose. Bureaucracy does not support such warriors; it tries to get rid of them. William S. Lind:

‘Boyd is best known for coming up with the OODA Loop or Boyd Cycle. He posited that all conflict is composed of repeated, time-competitive cycles of observing, orienting, deciding, and acting.

‘The most important element is orientation: whoever can orient more quickly to a rapidly changing situation acquires a decisive advantage because his slower opponent’s actions are too late and therefore irrelevant — as he desperately seeks convergence, he gets ever increasing divergence. At some point, he realises he can do nothing that works. That usually leads him either to panic or to give up, often while still physically largely intact.’

And yet, bureaucracy — zombies, looking out for themselves, not for the security of the nation — is what you get when you have too much money and no worthy enemies.

More to come…

Regards,

Bill Bonner
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

From the Archives…

Foreigners Turning on the US
16-08-2013 – Greg Canavan

Silver, The Devil’s Metal
15-08-2013 – Greg Canavan

Detroit, Demographics and Detonation
14-08-2013 – Vern Gowdie

Why Gold Has an Interesting Tale to Tell
13-08-2013 – Bill Bonner

China’s Economy… Stabilising, Bottoming, Rebounding
12-08-2013 – Greg Canavan

1 Comment

  1. slewie the pi-rat says:

    the markets are in “fatigues” over the FED.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au

Receive our unique and useful investments ideas straight to your inbox for FREE, enter your email to sign up:

x