Lower Interest Rates On the Way...

Long-term interest rates are at 40-year lows. Could they possibly go lower? Economist Gary Shilling says they can. Before this bull market in bonds is over, Gary predicts that long-term interest rates in the U.S. will touch 3%. Before you dismiss Gary as crazy, you ought to know that he's been Wall Street's most correct interest rate forecaster for decades. As he said in the latest issue of Forbes: 'I've been almost alone since 1981 in consistently recommending the long bond.' He's been exactly right, all along...

Unbelievably, the bonds that Shilling has recommended since 1981 have actually outperformed stocks since the bottom of the stock market in 1982. No joke... Stocks have returned a fantastic 15% a year (compound annual gain) since the bottom in 1982. But the bonds Shilling recommends (25-year zero coupon Treasury bonds) have returned an astounding 21% compound annual gain since interest rates peaked in 1981. Wow!

Shilling isn't letting up. In Forbes, Shilling says if long-term interest rates fall down to 3% over the next two years, the total return on the long-term zero coupon Treasury bond he's recommending will be 48%! (Remember, as bond yields go down, you make capital gains. The particular investment he's recommending is the zero-coupon Treasury that matures in August of 2029.) Gary pulls no punches. He concludes his Forbes article by saying: 'The bond rally of a lifetime is still under way. If you don't already have it, consider meaningful exposure to Treasury bonds. For the biggest action, buy zeros. Yields have come a long way from 14.7% to 4.5%, but there's still one big rally left.'

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You may think it's impossible to see long-term rates go much lower than they are today. You may say there's no precedent for this. Ah, but there is... Japan. Japan's rates went below 1% after Japan's bubble burs Japan's asset bubble peaked around 1990, and long-term interest rates in Japan at the asset bubble peak were above 6% - the same as they were in the U.S. at our stock market peak in 2000. (I'm using 10-year government bonds, as examples for both countries.) Five years after the asset bubble peak in Japan, long-term interest rates had fallen to 4%.

Now, here in the U.S., five years after our stock market peak, long-term interest rates here are 4%. Yet again, the same as Japan's... Long-term interest rates in Japan actually bottomed out below 1% in 2003, 11 years after Japan's asset bubble burst. Could Gary Shilling be right? Could long-term interest rates in the U.S. fall below 3%? Judging by Japan's example - and Japan is the only recent example we have of a bubble bursting in a developed country - Gary may not be as crazy as many think. Gary Shilling's prediction of 3% interest rates may be right on the money... just as his predictions have been for decades.

Whether you agree with Gary Shilling or not, you can't dismiss Japan's example. The popular wisdom is that higher interest rates in the U.S. are a 'sure thing.' Shilling's analysis and Japan's example should be enough to keep you from going along with the crowd... Personally, I'm definitely avoiding the popular wisdom, as I'm not placing any bets on higher interest rates in the U.S. in the near future.

By Dr. Steve Sjuggerud, as featured in the Investment Academy E-letter

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