Four False Assumptions That Can Kill Your Portfolio

It’s been so long since interest rates had a real “up” cycle that Wall Street — and many average investors — have forgotten what that even looks like.

Indeed, I count no less than four toxic interest-rate assumptions that have the potential to kill your portfolio:

First, Wall Street thinks the Federal Reserve can control all interest rates with a few words or the wave of a monetary wand.

Second, Wall Street thinks that when interest rates go up, it’s always a slow and gentle climb.

Third, Wall Street thinks that rising interest rates are solely a consequence of an improving economy and nothing else.

And fourth, Wall Street thinks that because of that, the impact will be benign.

Rising interest rates are not painless for homebuyers shopping for a mortgage.

I am here to tell you that Wall Street couldn’t be more wrong!

Let’s start with assumption No. 1, that the Fed is truly in complete charge of the interest rate markets …

If that were true, the impact from Chairman Ben Bernanke’s tame “taper talk” back in May and June would’ve worn off quickly. That’s especially true this time around considering virtually every Fed governor and regional bank president came out after rates started surging to say: “Calm down, all is well, don’t panic.”

Yet what happened?

The 10-year Treasury note yield gave back only about 20 basis points of its 100-basis-point surge. Then after that, yields surged again to new highs, as if the Fed hadn’t done or said anything at all. That only confirms what I have been saying for several weeks now: The Fed is losing control of the bond market.

What about assumption No. 2, the one that claims interest rates only climb in a slow and gentle fashion?

The Fed has tried to encourage that thinking by saying it will only gradually, slowly and predictably reduce its quantitative-easing program if and when it decides to.

But there is nothing slow and gradual about the 110-basis-point surge in long-term rates we’ve seen — in less than three months. This is one of the biggest increases in years, 69 percent and counting if you measure in percentage terms. That’s like the Dow Industrials exploding to more than 26,200 from recent levels … in less than a single quarter.

On several historical occasions, rates have risen even further and faster than that. Ten-year yields almost doubled from 2.07 percent to 4.01 percent in just six months in late 2008 and early 2009. They surged from 5.6 percent to 8.16 percent in 10 months in 1994.

Heck, 3-month Treasury bills exploded to 15.2 percent from 9.5 percent in just seven months in late 1979 and early 1980. In other words, assumption No. 2 is total bunk.

Who Likes Higher Interest Rates?

Then there are the third and fourth assumptions — that rates rise only because the economy is improving, and therefore investors should actually be happy that rates are climbing.

Happy? I don’t know about you …

But I doubt anyone shopping for a home is very happy that mortgage rates just shot up at the fastest weekly rate in 16 years.

I don’t think anyone who owns REIT stocks is happy she just lost more money — in such a short span of time — than in any period since the August 2011 debt-ceiling crash.

I’m skeptical that anyone who listened to the bullish analysts is happy that the average housing stock has lost every penny of gains since last September.

I’m not so sure municipal bond investors are happy they just suffered the worst wipeout in almost five years.

And I’m pretty certain that owners of zero-coupon bonds aren’t thrilled about losing 29 percent of their money in the past year — on supposedly “safe” U.S. Treasury securities.

Bottom line: Rising interest rates are not painless. They are not a good thing for most bondholders — and owners of many stocks either.

In fact, past major surges in interest rates helped …

• Cause the then-worst recession since the Great Depression in the early 1980s …

• Force hundreds of savings and loans into insolvency in the late 1980s …

• Drive Orange County, California, into bankruptcy in 1994 …

• Ignite the Long-Term Capital Management crisis in 1998 …

• Pop the Internet bubble in 2000 and …

• Prompt the biggest housing-market crash in history starting in 2005.

Here’s What to Do

So here’s my advice: Don’t buy the Wall Street line that surging interest rates are a net positive. Don’t fall victim to the four fatal assumptions I outlined above.

Instead, do what I’ve been doing in my Safe Money Report. Get the heck out of the way of this interest-rate surge and bond-market crash. Or better yet, harness the crash to rack up major profits.

Consider this: The average long-term, diversified bond fund has lost 2.8 percent so far this year, according to Morningstar. The average long-term municipal bond fund has dropped 5 percent. And the average long-term government bond fund has tanked almost 11 percent.

But my interest-rate-related/bond-alternative recommendations are trouncing various bond fund averages by double-digit margins. And if I’m right about where rates are headed — as well as the potential fallout — that’s just the beginning.

So please continue to pay attention to my interest-rate warnings and recommendations. This is not your average, every-day interest-rate market we’re dealing with, and that means the potential losses to avoid — and potential profits to achieve — are large indeed.

And if you want to see some outsized gains my subscribers and I have benefited from, click on this link to head to our Facebook page. You’ll see how we beat averages by double-digits. See you there.

Until next time,

Mike