Have US Treasury interest rates and the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) gone too far, too fast? I could be asking that question about 2023’s TLT moves in both directions, but my focus here is on its recent gigantic rebound in price. For those new to bond investing, prices of bonds rise when the rate on those bonds declines, and vice-versa.
I suspect many investors are getting more familiar with the bond market. I’ve been working with it since the 1980s, and I can truly say I’ve never, ever seen it like this.
I see today’s US Treasury market divided into 3 clean groups:
1. T-bills and bonds out to about 2 years maturity remain a gift from the financial market heavens.
Getting paid 5.25%-5.60% for 6 months, a year or even 2 years on a chunk of my portfolio to see how the recession, inflation, Central Bank Policy, wars, US Presidential Election and a bunch of other market concerns play out? Sign me the “Fed” up! As I’ve written here all year, T-bills (BIL, SHV), Treasury Floating Rate bonds (FLOT) and more recently 2-year Treasury Notes (UTWO) have been the anchor of my portfolio since the summer of 2022, increasing in prominence in the portfolio as short-term rates continued to rise, and the stock market, ex-7 mega cap stocks, stagnated. I’ve also bought the same type of bonds directly through my brokerage account, and have had many enjoyable discussions with Seeking Alpha members in the comments section about this topic. As of this latter stage of 2023, not a darn thing has changed about that.
2. Those higher yields were creeping up the yield curve through much of this year, and have now stalled.
The chart below shows this. For instance, 3-year bonds hit the “magic” 5% mark just 3 weeks ago. And 5-year bonds nearly got there as well.
3. The long-term end of the Treasury curve (10-30 years out) finally caught up, then had a mini-crash.
It was slow to tag along with the increase in T-bill rates, then rocketed higher as the markets started to get more concerned about the US debt, and the failure of Congress to get organized about slowing its progress. At least, that’s one explanation. The other is the pullout of some of the biggest buyers of US bonds: Japan, China and the US Federal Reserve, which babied the bond market and the economy for way too long with interest rates not befitting an expanding economy. All of the above and more got us here.
That chart below shows how this has all played out. I charted the curve as of 3 different dates.
Red = 7/31/23, the date the stock market topped out this year
Green = 10/19/23, the date bond yields peaked
Blue = 11/7/23, the day I’m writing this
If you did a “Rip Van Winkle” and fell asleep from the start of August until now, about 3 months later, you’d look at the bond market (the red line from when you fell asleep and the blue line from when you woke up) and say, “I see that yields continue to creep up, methodically.” But that method has turned to madness.
Just look at what is happening in the bond market. Repeating: the bond market! The first chart below uses annualized standard deviation over the past 1 year. Standard deviation is a measure of price fluctuation that allows us to compare any 2 securities head-to-head. Clearly, the SPDR S&P 500 ETF (SPY) is expected to be more volatile than TLT, which owns 20-30 year obligations of the US Government. And it usually is more volatile. That is, the orange line is usually above the purple line.
But that is not the case right now. TLT volatility has spiked, making it look more like a casino than a place where the debt of the country considered the “reserve currency.” is traded. Sure, long-term bonds are more volatile than short-term bonds. And if we look at high yield bonds or those from some parts of the emerging markets, we’ll find volatilty on a regular basis. But this is highly unusual.
Below is a chart of 10-day returns. Frankly, I never thought I’d even need to run a chart like this! But when an ETF like TLT can spike in price by more than 5% in 10 days, as it has done a few times this year, that gets my attention. And it should get yours too, even if you don’t invest in bonds or bond ETFs. Because it tells me that something is going on that changes the way we look at all markets right now.
The interesting thing about the next chart, a technical picture I created and the type of thing I watch every day, is that you can see just how much TLT has fallen in value. From early August 4, 2020, it fell by over 45%. Let me remind you, this is part of the bond asset class, and is at least a slice of many balanced portfolios, 60/40, etc.
The other thing to notice in the path TLT has taken is that the pace of its decline increased starting in late 2021, as I show via the bend in the purple line. When a downtrend shifts to a sharper angle like that, it is meaningful, and dangerous. And so, it was. That is when I started to make greater use of TBF, an ETF that essentially shorts the type of bonds that TLT holds. That position is a small fraction of what it was about a month ago.
And then, it happened again. The angle of descent dropped again, which is the blue line. This led to a fierce runup in bond yields, with the 10-year and 30-year reaching about 5%, which to many was probably considered impossible a year earlier.
The purple line shows the first “target” for TLT if this is truly going to be a reversal. It blew through it this week, and now the blue line is the next test. That would only take the price of TLT back to where it was in September. That translates to a 10-year yield of 4.25% and a 30-year yield of about 4.35%.
The chart above shows that the 10-year yield has reached a critical point. And that’s why, after keeping notes on this for about the past 10 days, I’m writing this now. The pair of black lines are a trend channel, which is threatening to bust to the downside.
In other words, the yield range that has been in place since April of this year is on the verge of ending. If that breaks hard (as opposed to jumping above and below the line, or stalling at the “support” level) yields will continue down, perhaps with great speed. And TLT will rally further, making up for more lost time and value.
All signs point to this happening. However, 2023 has been the year of the chart “fakeout,” where price moves quickly, then suddenly reverses just as the big sustained move is about to happen. I’ve been charting since 1980, when I was 16 years old, and I think the flood of new technicians has created a lot of group think. But the big-money forces of institutions, hedge funds and increasingly complex strategies make it so that just “reading the chart” as if you were asking an AI robot to do it for you, is a very risky strategy now. That’s why I still chart “by hand” so to speak, looking at every one and foregoing the filtering and screening systems that are now popular. Call me old fashioned!
But when I do that, I notice things like you see on the left side of the chart. Those ovals show that 2 other times this year, we have seen a spike lower in yields which caused TLT to surge in price. But like I said, this is 2023, so the moves did not last long.
The difference today is the market’s narrative. The popular refrain is that the Fed is done raising rates, they will cut by next year, and buying long-term bonds at these levels (around 4.5% on the 10-year) is akin to a steal.
That may be the case, but even if it is, there’s a much bigger issue at hand. I’ll remind you again, this is the bond market! And my concern is that some investors just see “TLT” and think “how I buy bonds” when in reality, TLT is acting like a juiced asset class. So my suggestion is simply to tread carefully.
GOVI: The alternative
And finally, that brings me to Invesco Equal Weight 0-30 Year Treasury ETF (NASDAQ:GOVI). Its asset base is nowhere near TLT’s $40 billion, sitting at $707 million. GOVI is not the mania TLT has become, because it doesn’t have the potential “appeal” of buying the longest-term bonds at the bottom. That’s the greed factor that has led to TLT’s assets doubling the past few years, despite its price being nearly cut in half. Think about that math for a moment.
GOVI is very liquid and while it has the same risks as TLT, they are muted due to the way it is structured. It allocates evenly across all 30 years of the US Treasury curve, so about 3% or so to each year. It holds 32 bonds in total as of now, all US Treasuries. That means that the portion of GOVI that is similar to all of TLT is about 1/3 of the fund (the last 10 years on the 0-30 spectrum).
GOVI’s portfolio yields about 4.2%, but don’t get fooled by that figure! The average price of its bonds is $87, so many of the longer-term bonds it holds are selling below “par” value. The average coupon of the bonds GOVI holds is 3.76%, since many Treasuries have not had auctions since rates were much lower. That means that GOVI has not replaced the bonds with more current, higher rates yet. For income purposes, T-bills, which are issued very frequently, have the most current, 5%-type yields.
By comparison, TLT’s average coupon is only 2.65%, which mean that it is even more leveraged to bond yields that it would seem at first glance. The average price of a bond in TLT’s portfolio is about $66.
GOVI: Some of TLT’s attractiveness, with the cushion of shorter-term bonds in the mix
TLT is attractive to those convinced that long-term rates will plunge from here. I am applying a bit of trading capital to that move, but when I make an investment move here, GOVI is going to be at the top of my list of candidates. That’s because my goal is not to trade long-term bonds. Not after the chaotic price action I’ve seen lately. I’ll leave that to the day-traders and full-time speculators.
The added benefit of GOVI is that since I am so heavily weighted in short-term Treasuries, there is some overlap with GOVI, which allows me to free up some of that T-bill exposure. But to be clear, I’m in no rush to do that!
Be careful out there. Long-term US Treasury bonds are not supposed to act like this. And when, on occasion they do, keeping position size reasonable. I’m treating TLT and others of its ilk as tactical situations until there are clearer, fundamental signs that the recent drop in bond rates move is sustainable. Otherwise, it is a recipe for always being one step behind the market.