Wednesday, January 7, 2009

Long Term Treasury Bonds: Update

I have been bearish on long term Treasury bonds long before it was fashionable, and this past week, Barron's has a cover story on Treasuries entitled, "Get Out Now!" It is their belief that "the bubble in Treasuries looks ready to pop, sending prices on government debt sharply lower."

More on the Barron's "call" below, but for now let's review the technical picture. See figure 1, a monthly chart of the 10 year Treasury bond. The "next big thing" indicator, which guages the probability of a secular trend change occurring within an asset, is in the bottom panel. As you can see, the "next big thing" indicator is in a position that would be consistent with past secular trend changes. These are indicated by the purple vertical bars, and with the exception of the signal in 2002, the indicator did a reasonably good job of identifying prolong periods of underperformance by Treasury bonds in what has become a 25 plus year bull market.

Figure 1. 10 Year Treasury Bond/ monthly

So the "next big thing" indicator only suggests that a market top is highly probable, and so the next thing to look for is some sort of price confirmation. Let's return to figure 1 and now focus on the gray ovals over the price bars. The gray ovals highlight negative divergences (pink bars) between price and an oscillator used to measure price momentum. More specifically, the pattern I am looking for is a cluster of negative divergences, and this is a pattern not only seen at important tops in bonds but multiple asset classes over various periods. There is already one negative divergence bar from 4 months ago (pink price bar with red arrows underneath), and there is a high probality that there will be another negative divergence bar in the next several months. In all likelihood, this would represent the "top" in bonds.

So it is highly likely, from this perspective, that Treasury bonds will be an underperforming asset class over the next 12 months. But more importantly, will this market top lead to an investing opportunity (i.e., by shorting Treasury bonds)? In other words, will the market top lead to a secular trend change in Treasury bonds?

That is more difficult tell. And one of the reasons, I state this is the fact that everyone is looking for it. It is right there on Barron's cover. Everyone now knows that Treasury bonds are a bad investment and this is rarely a recipe that leads to a secular trend change. Think back to the major trend changes of the past year. Crude oil topped out amid "calls" of $200 oil. The US Dollar Index bottomed amid "calls" for the crashing dollar. Markets rarely reverse when everyone expects them too.

So let's summarize. Long term Treasury bonds are in the topping process and do not represent a good investment. At this point in time, one could speculate in anticipation of a trend reversal in long Treasury bonds by selling strength in Treasury bonds. There are two investing vehicles that bet against Treasury bonds (i.e., higher yields), and these are the Ultrashort Lehman 20+ Year Treasury Proshares (symbol: TBT) and the Ultrashort Lehman 7-10 Year Treasury Proshares (symbol: PST).

1 comment:

Guy M. Lerner said...

One thing I forgot to mention regarding a headwind when it comes to higher Treasury yields (i.e., lower bond prices) is government intervention. It is not in the best interest of the government to see higher yields; therefore, "they" will do whatever they can to prevent it from happening. Although bonds should put in a top, it doesn't necessarily mean that they will reverse and start trending lower.