Buyer interest in 30-year treasuries comes in low … why this is a problem for the stock market and our government’s debt obligations … the disconnect between the S&P and long-dated treasuries

 

Last Thursday, something troubling happened in the financial markets that most investors missed.

You need to be aware of it because it’s already impacting your stocks, with additional influence to come.

Simply put, the government’s sale of $23 billion in 30-year Treasury bonds didn’t go well. Because there wasn’t an abundance of buyers, it produced a selloff in these bonds which spiked the 30-year yield to 4.27% on Friday. As I write Monday morning, the yield is still climbing, now at 4.29%.

As you can see below, the 30-year yield has almost reached its most recent closing high from last October.

While this might sound boring and somewhat irrelevant, it’s important to the markets and to you.

We’re watching the “big muscle movements” of the financial markets play out with this spike in long-dated government bond yields. This will have a trickle-down effect on smaller markets and sectors, ultimately impacting your portfolio.

To unpack what’s going on, let’s begin with legendary investor Louis Navellier. Here he is from last Friday’s Accelerated Profits Special Market Update:

Well, folks, we have a bit of a problem.

The 30-year treasury bond auction [last Thursday] did not go well. So, interest rates are up. The 30-year treasury yield is now 4.14%.

After its bonds were auctioned [last] Wednesday, the yield was 3.99%. So, this is a significant increase in yields in the wake of our record treasury refinancing, and that’s a problem.

As I noted a moment ago, that 4.14% yield that had Louis troubled is now all the way up to 4.29%.

So, what does this mean – most importantly, for you and your portfolio?

How the government’s spending problem could become your portfolio problem and your child’s quality of life problem

In the Digest one week ago, we profiled the enormous economic problem facing our government.

In short, it owes more money to its creditors than it could ever hope to pay back… it’s promising an ever-expanding laundry list of costly entitlements and programs… and it has zero ability to pay for all these financial obligations through tax revenues.

So, how has it been funding this black hole of spending?

Through debt – government bonds, including the 30-year treasury we’re discussing.

Now, as you might expect, when the size of the government’s financial obligations skyrockets yet its tax revenues don’t, that points toward an obvious solution: “issue more bonds.” And that’s exactly what we’ve just seen happen.

From Bloomberg last week:

The US Treasury boosted the size of its quarterly bond sales for the first time in 2 1/2 years to help finance a surge in budget deficits so alarming it prompted Fitch Ratings to cut the government’s AAA credit rating a day earlier.

Specifically, the Treasury Department bumped its planned auction amount of $733 billion to $1.03 trillion. That’s a whopping 36% increase.

Now, these new bonds come with a variety of time-horizons. There were 3-year notes which had strong demand earlier last week. There were the longer 10-year treasuries that had fair demand. And then there were these long-dated 30-year treasuries that had poor demand.

Basically, although buyers are willing to take on shorter-term duration risk with the government, they’re increasingly less interested in longer-term risk, especially given the far-greater size of the bond issuance.

Here’s Bloomberg:

US Treasuries came under renewed pressure, pushing yields higher, as the market struggled to absorb [last] week’s final leg of new debt sales…

The [30-year bond sale] was the biggest test of this week’s auctions…because the long maturity securities usually appeal to select investors such as pension funds and insurers.

“[The 30-year treasury selloff] feels likes a reaction to the weak auction,” said Subadra Rajappa, head of U.S. rates strategy for Societe Generale.

“…Dealers had to take down a big chunk of the paper. It feels like there’s not enough of real money participation.”

The lack of buyer interest is troubling for several reasons

First, it illustrates the potential for a doom loop wherein yields must climb higher (which means prices fall) to lure buyers.

But higher yields add to the government’s debt obligation by increasing the size of its interest payments. That results in even greater government spending, which requires more bond issuances at higher yields. Rinse and repeat.

Here’s the Peter G. Peterson Foundation (a self-described “nonpartisan organization dedicated to increasing awareness and accelerating action on America’s long-term fiscal challenges”):

Rising interest rates and growing national debt cause federal interest costs to rise. And interest costs, in turn, contribute to the growth of federal spending — continuing a vicious cycle of borrowing, interest, and higher debt.

Interest costs also crowd out opportunities for investment in other important priorities. In fact, the government is already on a path to spending more on interest costs than its spending on education, research and development, and infrastructure combined.

Below is a chart showing projected government spending obligations (in red) relative to government revenues (in blue) stretching out to 2053.

You can see the red spending line climbing at a steep slope while the blue revenue line barely edges higher.

And that gap in the middle of those two lines?

That’s the deterioration of our country’s economic strength and quality of living, which will be felt most acutely by our children.

In the meantime, be aware of what this spike in government yields means for your stock portfolio

In last week’s Digest, we highlighted why surging bond yields are bad for the average stock portfolio.

From a valuation perspective, higher bond yields put upward pressure on the discount rate used to value a company’s stock. Given the math involved in this calculation, the higher the discount rate, the lower the net present value of future flows, and vice versa.

So, higher long-term government bond yields – and by extension, a higher discount rate – are a drag on stock prices. We saw this play out at the end of last week as the S&P fell on both Thursday and Friday, despite a great CPI report on Thursday.

From a competition perspective, the higher the yield of “risk free” government bonds (if held to maturity), the more it lures conservative investors away from stocks, which creates another downward pressure on stock prices.

Let’s circle back to the chart at the top of today’s Digest to bring home the risk to your portfolio

Here’s the chart again of the 30-year treasury yield showing today’s 4.29% yield about to top last October 21’s closing yield of 4.33%.

So, we have a “then” versus “now” 30-year treasury yield that’s practically identical.

But guess what’s not the least bit identical between then and now…

You got it – the S&P.

Last October marked the low of the 2022 bear market. But between then and now, the S&P has exploded 22% higher.

And yet, rather than move lower as stocks have climbed higher, the 30-year treasury yield has been surging.

It doesn’t work this way usually.

As you can see below in a chart comparing the S&P and the 30-year treasury yield dating back to the beginning of 2022, the S&P usually falls as the treasury yield climbs.

But here we are with the 30-year treasury yield back up to where it was at nearly the absolute low of last year’s bear market…at the same time, the S&P isn’t far beneath its 52-week high.

This imbalance should not be overlooked

Yes, such imbalances can remain for far longer than many investors expect (that’s how people lose huge amounts of money). But eventually, equilibrium returns.

In this case, the market can achieve equilibrium two ways: 1) bond yields fall as renewed buying pressure returns to the government bond market, or 2) stock prices fall as the impact of elevated bond yields reverberates through the financial markets.

Given our nation’s mindboggling financial obligations… the reality of the tidal wave of new bond issuance hitting the market to pay for government debt… and the much-lower buyer interest in these longer-dated bonds… which outcome do you find most likely?

Before we sign off, mark your calendar for Wednesday August 16 at 8 PM ET

Regular Digest readers know that our macro expert Eric Fry has been wildly bullish on AI this year. Better still, in just the last couple weeks, his Speculator subscribers closed triple-digit returns – twice – in two different AI stocks.

But while Eric believes the AI megatrend will nurture a growing number of lifechanging investment opportunities over the coming months and years, there’s a dark side too.

On that note, here’s Eric:

…We’re on the verge of a massive AI panic that’s going to blindside Americans just days from now…

I can confirm at least 37 Wall Street banks that oversee a combined $12 trillion have quietly been preparing.

To explain what’s happening, and provide a blueprint for the best investment response, Eric is holding a briefing this Wednesday at 8 PM ET. To reserve your seat, just click here.

We’ll bring you more details on this event here in the Digest later this week. For now, I’ll give Eric the final word:

During the event, I’ll show you how making a few moves could turn this panic into 1,000% profit potential or more in the days ahead.

Go here to secure your spot now and prepare for the coming $3 trillion AI panic.

Have a good evening,

Jeff Remsburg