While investors and the media focus on the stock market, the real action continues to take place in the bond market. The bond market warnings we wrote about in October and again in November did indeed crash onshore in the past couple of weeks.
While I’m obviously not surprised by the spike in long-term yields, I think that the corrections we’ve seen in the bond markets are overdone … and that this is likely a good time to consider locking in some of the higher yields we’re seeing today.
Before I get to why I believe that the bond market rout is overdone, let me remind you that what I write here on Fridays may or may not be in lock-step with current TradeStops signals.
TradeStops algorithms do a great job of covering 95% of our decision making needs and keeping us out of trouble, but once in a while, we see things that look likely to preempt our algorithms. A good example is our call this year on a rising US Dollar. We started calling for a stronger US dollar way back in May, long before a new SSI entry signal was eventually triggered on November 17th.
We think that we may now be seeing a similar situation developing with US Treasuries.
It’s a pretty daring call because the SSI chart on 10 year Treasuries looks absolutely terrible. The SSI is solidly in the red after having been stopped out over a month ago, and there is no sign of a bottom in sight.
So why on earth would I suggest this might be a good time to lock in some higher yields?
Just looking at the one-year chart above, it would be very easy to be negative about the downward direction of Treasuries (and upward pressure on yields), but let’s take a “bigger picture” view.
Back in 2013, the 10-year Treasury Note had a similarly steep drop from a higher level. We have now dropped back down to the highest level from 2013. There is strong support at the 120 level which is just a few points lower from where we closed yesterday.
And the commercial traders are as bullish as they’ve ever been. The most recent COT (Commitment of Traders) report shows that the traders have nearly their largest long position on record. Open interest on the futures contract is also near an all-time high. Higher open interest means that more capital is flowing into this market.
The red, oval highlights in the chart above show how in the past this level of bullishness has preceded higher moves in the Treasury markets.
The time-cycle forecasts have been doing a great job of forecasting T-Note prices. Right now, the time-cycles analysis very strongly suggests a bottom is near. We should start seeing higher prices by the beginning of 2017.
I’ve highlighted the long-term trend line in Treasury yields recently. The downtrend has definitely been broken, though we’ve seen this kind of brief breach of the downtrend a few times before. We will need to see something more decisive before we start quaking in our boots.
While the broken trend line is something to keep a close eye on, there’s another perspective on this trend that I haven’t shared before … the logarithmic trend.
When looking at very long-term trends, it’s useful to use a logarithmically scaled chart. On a log-scaled chart, equal vertical distances represent equal percentage changes. Bear with me for a minute while I briefly explain this concept.
If you look on the chart above, a move from 9% down to 8% is a 1% drop, but it’s also 11.1% of the distance from 9% down to 0% (i.e., 1% divided by 9%). Right?
On the other hand, a move down from 3% to 2% is also a 1% move, but it’s 33% of the distance from 3% to 0%.
Alright, if you’re eyes aren’t too glazed over from the math, now take a look at the log-scaled version of this same data below. You can see how the distance of 9% down to 6% is about the same vertical distance from 3% down to 2%. Both represent 33% falls.
OK … math lesson over. Now let’s talk about what this means.
When we look at the long-term trend of T-Note yields from this log-scale perspective, it shows something very interesting. It would take T-Note yields north of 4% to decisively break this long-term downtrend.
That’s a LONG way from where we stand today. Even Janet Yellen’s three planned hikes next year won’t add 1.5% to long-term yields.
We’re still largely in a zero interest rate world … and some of the safest investments on earth, US Treasury Notes, are now yielding 2.5%. How long do you think that is going to last?
Commercial interests (aka smart money) are buying … and the time-cycles are bottoming.
These conditions could be the Christmas present that income investors have been looking for.
Have a great weekend,
Richard Smith, PhD
CEO & Founder, TradeStops