Imagine this scenario: It's an election year, the incumbent Democratic Party is looking to gain control over Congress and the White House, outgoing president Bill Clinton wants to leave Americans with a good taste in their mouths concerning his "legacy," and all parties concerned want the U.S. stock market and economy to keep roaring along. Since we are in the fourth year of the famous "Presidential Cycle," we are told to expect a booming economy, a soaring stock market, and falling interest rates. Yet here we are almost halfway through an election year and the stock market is no longer making new highs. The economy continues to perform well, but signs of disruption are making their appearance (such as a noticeable decline in housing starts and some real estate prices). Most ominously, interest rates are not declining, but instead are far above their lows of 1998 and threatening to move even higher. What in the world is going on here?

Consider further: In an obvious effort at artificially lowering interest rates during an election year in order to give the incumbent party a better shot at picking up seats in November, the federal government announced recently that it has begun repurchasing its long-term debt. In principal, this is designed to diminish the outstanding supply of Treasury bonds, thereby increasing bond prices (while simultaneously shrinking the interest rate on the 30-year T-bond). Notwithstanding the latest efforts of the government at buying back its long-term debt, yields on the long bond are not declining; in fact, they are starting to climb once again. This also holds true for yields on the 10-year and 5-year Treasuries. What, therefore, does this mean? When the government is making an overt attempt at bolstering the value of its debt only to see its value decline in the eyes of investors, what does this portend? Could it mean that federal debt held by overseas investors is being repatriated? Are institutional bondholders emptying their portfolios of government debt in anticipation of a further decline in value? What exactly is going on here?

Here's another corker: The Federal Reserve Board, which one would assume would be committed to helping out the Clinton's any way they can, isn't helping matters by continually boosting Fed Funds interest rates (5 consecutive times thus far). Worse, the Fed threatens to continue boosting rates until the "economy slows down."

But the plot thickens still further: Another, similar, phenomenon that bears mention is the fact that highly-rated "blue chip" corporate bonds are declining in value even as government bonds decline. The prime measure of corporate debt value—the Dow Jones Bond Index—broke below a major support level this week, continuing a nasty downtrend from recent months. The advance/decline line on the DJ Bond Index also reflects a bear market in bonds. Is the bond market sending a message that corporate debt is on shaky ground? Are declining corporate bond prices warning of a coming decline in corporate profitability?

Before these questions can be answered, it is essential that we all understand some bond (i.e., debt) market fundamentals. A rising price for bonds equates to a falling interest rate, which is bullish. Falling prices equate to rising interest rates (bearish). Rising interest rates mean that the cost of borrowing is rising, which tends to crimp economic expansion and corporate profitability by discouraging borrowing and raising the cost of loan amortization. Thus, rising interest rates are not a positive sign.

Many who are bullish on the U.S. economy argue that the rising rates of interest will not hinder the expansion since the rate increases are viewed as "sustainable" as they stand. But some would argue that the current bubble economy is based on an assumed rate of interest below 6 percent; hence, the current rise in interest rates could prove quite damaging. Our own analysis tells us that the closer rates get to 7 percent, the more unsustainable the rate becomes to our present expansion. While some argue that it will take double digit rates to "kill" the economy, we are convinced a 7 percent rate would do the trick. The 5-year bond, a proxy for other interest rates, is fast approaching this level.

It is important to remember that nothing kills a bull market faster than rising interest rates. When interest rate increases are accompanied by a contraction in the money supply, it proves even more onerous. Considering that Greenspan and Co. have already initiating this fateful pattern—the same one that produced the Great Crash of 1929—it becomes downright frightening to consider.

The debt bonanza consumers have enjoyed over the past four-to-five years is coming to a grinding halt. Unfortunately for most of them, the realization that the party is over will come only too late and with considerable pain. We know from recent statistics that consumer debt loads are at all-time high levels, and much of that debt load is indexed with variable interest rates. Imagine the collective cry of agony when it finally dawns on the consuming masses that more and more of their incomes must go to amortizing their prodigious debts, and at increasing interest rates. We have a feeling that the rising chorus of voices in favor of international debt relief will soon extend to consumers on the domestic level, as well.

The most important barometer for investors to keep an eye one right now is not the Dow or the NASDAQ, but rather the yields on the various government, bank and corporate interest rates. If the rising trend in rates continues much longer, the collapse of the stock market won't be very far behind.