Hard to tell if interest rates have hit bottom

It’s entirely possible that interest rates hit all-time lows earlier this month that will never again be seen in our lifetimes, as many are now proclaiming. If so, since bond prices move down when rates rise, bond values will never be as high as they were a few weeks ago.

But it’s worth remembering that past major market turning points were not recognized as such at the time by the vast majority of investors. This is a general truth that applies to all investment arenas, by the way, not just the bond market.

Consider the number of declarations over the last several years that interest rates had finally hit their all-time lows—and, therefore, bond prices had hit their all-time highs. Among the several hundred advisers and market timers I monitor, for example, an enormous amount of money has been lost by those confidently arguing that the markets were at just such a juncture. True to form, rates just kept going down—and down.

When interest rates do finally hit their lows, chances are good that few will be confidently forecasting a trend reversal. So we should be taking with an appropriate grain of salt the number of current pronouncements of just such a reversal.

A walk down memory lane can be helpful in appreciating these aspects of market psychology. Take the mood in September 1981, which turned out to be the month in which interest rates hit their all-time high. That month, for example, the yield on the 10-Year Treasury Note hit 15.8%. Over the century prior, the ten-year yield had never gotten above 10%.

Not surprisingly, as that yield in the late 1970s and early 1980s started to rise above 10%, bond market timers fell over themselves confidently declaring that rates couldn’t go any higher. Writing just a couple of weeks before the September 1981 peak, the late Richard Russell, theneditor of the Dow Theory Letters advisory service, commented on the widespread failure of those predictions. “If it wasn’t so pathetic, so insane, it would be comical,” he wrote. “You’d think the forecaster would show some sense of embarrassment, some shame” over his continued failures. But, instead, he lamented, most just keep repeating the same forecasts.

One of the very few advisers who got it right in the fall of 1981 was Dan Seiver, editor of an advisory service called The PAD System Report. In October of that year he initiated a big bet on lower interest rates by investing in U.S. Treasuries within just a couple of weeks of the bond market’s all-time low. Seiver, who is an emeritus professor of economics at Miami University in Ohio and a lecturer in economics at Cal Poly State University, tells me in an interview that his bet paid off so handsomely that it paid for his daughter’s tuition at Yale University.

Despite having that great call to his credit, Seiver today has given up trying to predict the final end of the interest rate decline that began then. He tried making just such a bet in early 2009, when the 10-year T-Note yield was below 3.0%. By December 2011, when that yield had fallen to 2.0%, he threw in the towel.

The 10-Year yield today stands at 1.57%, having dropped to 1.37% earlier this month.

Seiver says the situation today is not analogous to what prevailed in September 1981. “Then it was clear that the Fed was going to cause a recession to bring down inflation. So interest rates would sooner or later return to ‘normal’,” he told me. Today, in contrast, “the Fed is about as befuddled as the rest of us” and, as a result, the time frame over which interest rates will return to “normal” could be a lot longer than we think.

Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers' performances for four decades. For more information, email him at mark@hulbertratings.com or go to www.hulbertratings.com.