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May 28, 2017

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Stocks and bond rates causing some shock

If you had been away and came back to civilization after a few years' absence, you would have been shocked to see the numbers.

It's not the stock market that would have surprised you since it has always had its ups and downs and always will.

It's the interest rates that would have astounded you beyond belief.

The savings you get from a 1-year certificate of deposit is about 1%, while the 10-year bond yield is now 2.61%.

The good thing is the 30-year fixed home mortgage rate is now only 4.5%.

These rates could have only been made in Japan not too long ago.

Last week the Wall Street Journal published an opinion titled "The Great American Bond Bubble" by Jeremy Siegel, a professor of finance at the University of Pennsylvania's Wharton School who wrote the book "Stocks for the Long Run" that The Washington Post called one of the 10 best investment books of all time.

He pointed out that we experienced the biggest bubble in stock market 10 years ago when high-flying tech stocks were selling at excess of 100 times earnings, and a similar bubble expanding today is bonds now that the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%.

This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout and the investors would suffer capital loss once interest rate begin to rise. And the long-term stock bulls pointed out that the 10 largest dividend payers in the US AT&T, Exxon Mobil, Chevron, Procter & Gamble, Johnson & Johnson, Verizon Communications, Phillip Morris International, Pfizer, General Electric and Merck now sport an average dividend yield of 4%.

Many people got the interest rates wrong, yours truly included.

Coming into this year, many analysts also thought the U.S. economy's recovery would mean that the Fed would be raising interest rates pretty soon, a negative for bonds.

Morgan Stanley's head of global interest rate strategy Jim Caron issued yet another apology for his errant call on the U.S. Treasury market last Friday.

In the spring, Morgan Stanley was the most adamant of U.S. Treasury dealers that predicts Treasury would tank this year. Their reason: The government was going to sell trillions of dollars in fresh debt to fund itself, and this explosion of supply had to make government securities less valuable.

Goldman Sachs got it right in April seeing the 10-year yield hitting 3.25%, and are now calling for 2.5% yield at year-end and we are almost there.

Bond bears are calling it foul because the U.S. Treasury is selling billions of dollars in bonds which should have sent the interest rate higher, but the Federal Reserve is buying long-term bonds to keep the rate low to help revive the economy.

We believe what is happening today is the opposite of what happened in 2000.

Investors were too optimistic chasing high-flying stocks then and are now too pessimistic about the stocks.

Disheartened investors who have given up on stocks and are putting money in bonds are doing it at the worst of times.

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