Investors, Run for Cover From the Incoming ‘Taper Bomb’

Maybe it’s because I just spoke to our German partners and their clients a few weeks ago on the state of the markets. Or maybe it’s the holiday season. But for whatever reason, I couldn’t get the Christmas song “O Tannebaum” out of my head this week.

If I were you, though, I’d be thinking about another possible holiday surprise — the “taper bomb.” Because in just five days, the Fed could drop one right on your lap.

Look, I’ve been saying for a while now that the Treasury market has been trying to tell us something. Bond prices have been plunging for several months, while 30-year Treasury yields just briefly tagged a 28-month high. This has been happening despite aggressive bond buying by the Federal Reserve.

You can expect the Fed to kill its QE program within the next few months.

That bond market sell-off is leaving fixed-income investors (at least, those who didn’t heed my advice to get out of the way) with the worst annual losses on bonds since 1999.

It also proves beyond the shadow of a doubt that the bond market is more powerful than the Fed. If investors want out of bonds — due to fears of inflation, stronger growth, huge debts and deficits, massive foreign and domestic fund outflows, and so on — their selling will ultimately overwhelm any QE program the Fed can cook up.

Now, against that backdrop, the Fed is about to hold its last policy meeting of 2013. On Dec. 17 and 18, policymakers will gather around a conference table in Washington and decide whether to continue their $85 billion-per-month QE program.

My prediction? They drop a taper bomb and start dialing down those purchases, probably by at least $10 billion.

First, I’ve said for many months now that QE: 1. wasn’t accomplishing much, and 2. wasn’t even needed any more because the economy was healing on its own. Virtually every piece of data that has come out since then confirms my forecast is on track.

The most important recent report was the official November jobs numbers. It showed the economy creating 203,000 last month, well above consensus estimates in the high 100,000s.

More importantly, the unemployment rate dropped to 7 percent from 7.3 percent. That was far below the 7.2 percent that was expected and the lowest since November 2008. Average hourly earnings also rose 0.2 percent, while average weekly hours worked ticked up to 34.5. Finally, the diffusion index, which measures how many companies are adding workers versus cutting them, rose to 63.5 from 61.1.

And yesterday, we learned that retail sales surged 0.7 percent in November. That was faster than expected, an increase from the upwardly revised reading of 0.6 percent in October, and the biggest gain in five months. Strong retail sales should alleviate some of the concern that was out there about the buildup in inventories during the third quarter.

Second, the separate “JOLTS” report (which incoming Fed Chairman Janet Yellen closely follows) that the Labor Department puts out every month showed job openings hit the highest since May 2008 in October, at 3.925 million.

Weekly jobless claims also just plunged back below the 300,000 mark, putting filings for unemployment assistance back near their lowest levels since 2006-2007. That provides even more evidence of a firmer tone to the labor market.

Third, in response to all the stronger data we’ve seen lately, noted centrist James Bullard of the St. Louis Fed strongly hinted at an imminent taper in a speech this week. He joined more hawkish members, like Dallas Fed President Richard Fisher, who just warned that “we at the Fed should begin tapering back our bond purchases at the earliest opportunity.”

Finally, the Fed’s last major excuse — fears of another fiscal foul up in Congress — is being taken away. Congressional leaders worked out a federal budget deal this week behind closed doors. So there will be no threat of a government shutdown.

I suppose there’s a small outside chance the Fed punts to its late-January meeting. But I sure don’t want to bet on that outcome.

Instead, I expect to see many more hawkish shifts at the Fed over the course of the coming few months.

I expect the Fed will not only start tapering QE earlier than Wall Street currently believes (a forecast I laid out several weeks ago), but also completely kill the program sooner than that.

And if I had to pick one big potential shocker in 2014, it’s this: I expect the Fed will actually raise interest rates for the first time next year.

So if you’re sick of losing money on bonds, I have news for you: You ain’t seen nothin’ yet! I believe the Fed’s great rate experiment has run its course, and that we are now swept up in one of the biggest bull markets in history — a bull market in interest rates.

That means you have to get out of the way of the coming taper bomb before it nukes your portfolio. You simply can’t own longer-term bonds of any kind — Treasuries, munis, junk bonds, emerging market bonds, you name it. You also have to continue to avoid interest-sensitive stocks like real estate investment trusts (REITs), home builders, certain financials and more.

I don’t recommend you go and sell all your stocks, though. Those with leverage to an economic expansion, and those that can actually benefit from rising rates, look like solid plays to me.

In fact, I’ve identified key sectors that are in their own “private” bull markets, and helped guide my Safe Money subscribers to some of the strongest names in those sectors. I’m happy to report that several of them have done, and should continue to do, very well. And if you’d like more specifics, all you have to do is click here — ideally before the Fed’s meeting wraps up next week!

Until next time,

Mike