T-Notes: The Gift that Keeps on Giving

The S&P500 bounced back about half a percentage point last week in the usual light trading volume. Volatility barely budged….and remained stuck near decade lows. Fear of loss, clearly, is a concept that has completely disappeared from the average investor’s memory.

The technicals still point to an extremely overbought US stock market, especially on the longer term weekly charts. On the daily charts, there appears to be a slight loss of momentum. That said, every time this as happened since mid-2012, the positive momentum was subsequently regained. It’s too early to tell if the same thing will happen again…this time.  Also, the critical 200 day moving average is sloping upward and prices are holding well above it. Nothing really earth-shattering happens in the stock markets until both of these conditions change.

One interesting set of market divergences, however, ought to be noted. First, the Russell 2000 small cap index is down for the year, while the S&P500 is positive on the year. In many prior instances of general equity market declines, the small cap indices sold off first because the smaller firms were seen—correctly—as being more risky. So when investors wanted to sell stocks, they sold small caps first and held on to their large cap holdings because they perceived the larger firms to be less vulnerable to severe declines. Second, the high yield corporate bond market has started to sell off notably. While not showing a loss for the year, the HYG etf has fallen below its 50 day moving average for the first time in twelve months. This is an important signal because high yield bond investors tend to be somewhat more sophisticated that the average stock investor (ie. there are fewer mom-and-pop high yield investors that stock market investors) so when they sell, they tend to sell ahead of the general stock market.

Several times over the last year, we’ve noted how the US Treasury market was one of the few large and liquid asset classes that offered investors and traders some notable value. And while the very strong consensus on Wall Street vehemently disagreed, it has been proven wrong in an almost embarrassing way.

What’s even more interesting is that this trade has continued to work throughout the year. Over and over again, when the US 10 year note has sold off slightly, it—in retrospect—was nothing other than an attractive buying opportunity, because the price has always rebounded back up and provided traders with repetitive profits.  All the while, these traders continued to earn money from the coupon (positive carry) while waiting for the price to rebound.

As of last week, the yield on the 10 year Treasury once again dipped back down (meaning prices rose back up) to the mid 2.4% range. Just a week earlier, investors could have bought that same Treasury with a yield in the mid 2.6% range.

And this trade, or similar, has presented itself at least half a dozen times since the start of the year.

When will it end?

Well given that the Japanese 10 year government bond is currently yielding 0.54% (that’s right, about half a percent, or almost two percentage points LESS than the US 10 year!), and given that the trend in the Japanese government bond market has led the US government bond market by about ten years, then it’s possible that the US 10 year note can soar in price far beyond where it peaked in 2012.

So either as an investment, or as a trade, or both, keep your eye on the US Treasury market. It’s the gift that keeps on giving.



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