TLT: Something Wicked This Way Comes, Maybe.

by YoYo_Da

Just wanted to point out something I’d been noticing and have mentioned a few times in the discussion threads about bonds/equities as we near ATH.

TLT is an ETF that tracks the price of long-term treasury bonds. If you take a look at bond yields for the past month or so, they’ve been very rapidly increasing, with the 10Y-2Y and 10Y-3M spreads up at .55 and .61, respectively, as of today’s close. Normally, that’s a good thing. Higher yields usually represent upticks in economic activity, inflation, etc. Right now, though, it’s my belief that the markets are going to be skiddish about this, since rising yields almost always anticipate rising interest rates. Though Powell said at the last FOMC that they’re not even thinking about raising interest rates, I’m not so confident. Even if that promise is kept, though, I think the fact we’re closing in on ATHs could be a signal to large investors that there’s very little upside in equities at the moment. Still wanting to maintain good returns, investors could jump from equities to bonds at these low prices and high-yields, triggering an equity selloff. Imo that chance is amplified by the lack of a stimulus package and fears of a second COVID wave. Interest rising when there’s no stimulus is not good for the big players.

That might not sound all that convincing, though, since it relies on a lot of assumptions that you can agree or disagree with. So instead I’ll go with an even less convincing, if more objective, route: look at the charts. Price action of TLT roughly follows investor sentiment —> overbought = peak fear, oversold = peak greed, since they inverse interest rates.

Overbought date ranges are roughly 1/23-1/30, 2/20-3/9, and small blips on 4/17, 5/14, 6/11, 6/28, 7/10, and 7/23. Oversold ranges are 5/5-5/7, 6/2-6/8, and 8/10-8/14, with a small blip on 2/5.

I’m sure a lot of those dates already bring up some PTSD for a lot of you, so I shouldn’t have to explain all of them, but just to make the case a bit stronger I’ll show the same ranges on SPY.

Overbought dates: 2/5, 2/12, 4/7-4/9, 4/28-4/30, 6/3-6/8, 7/1-7/7, ~7/21, and roughly 8/6-8/14. Oversold dates: 2/21-3/1, 3/9-3/13, 6/11-6/15.

Now I know this isn’t shocking. Bonds and equities should be expected to have a reasonably negative correlation. But it being obvious doesn’t make the trend any less sound. Other pairings include (approximate dates):

Matching Bear Pairs (SPY oversold, TLT overbought):

SPY 8/2 – 8/8 of 2019 <—> TLT 8/13 – 8/28 of 2019

(20.51 pt drop from local high)

SPY Crash 12/3 – 12/26 of 2018 <—> TLT 12/3 of 2018 – 1/4 of 2019

(40.6 pt drop from local high)

2 SPY corrections between 5/1 – 6/3 of 2019 <—> TLT 4/19 – 6/19 of 2019

(22 pt drop from local high)

Now, to be fair, there are dates where the correlation doesn’t hold. The “digital currency” (post got deleted because I said the other word) crash was one, as well as several small SPY flash crashes throughout 2018. But since 2018, the comparison has held. And since the interest rate cuts of 2019, the trends have been more solid than ever.

SPY + TLT 2Y: 1D since 7/9/19

The rate at which bond prices are now dropping as yields rise might make it seem like we’ve still got a bit until it bottoms out and the trend reverses again, with TLT up and SPY down. But I think this will more likely happen before the FOMC in September. The selloff in June was, in my opinion, the result of the bad forecast from the Fed spooking investors out of equities and into cheap, long-term, high-yield bonds (this way they could maintain a good risk/reward without tying those returns to short-term performance of still-suffering equities).

So, compare the recent trend in bond yields to the last “milestone” FOMC, in June (by July’s FOMC we were still recovering from June). Important also to note is that July’s FOMC did not include a summary of economic projections, but like June’s, September’s will. If their projections are a lot rosier, I think we could see interest rate hikes then. Below is a chart with the US10Y yield compared to TLT over the same period from late April to now. I’m using the 10Y even though TLT is technically only 20+Y because the 20Y bond was only brought back this year and charts for its yield only show data starting in late May, but the general pattern of both remains the same.

US10Y — TLT

Looking at the chart, first thing that’s apparent is that there’s a textbook head-and-shoulders pattern on the 10Y, and an inverse HAS on TLT. This, accompanied by the fact that I *really* doubt the Fed will raise interest rates, tells us that the yield will fall soon and TLT will rise. The timing of that change, then, is the question. Looking at the chart, it seems that TLT just today hit the same bottom as its earlier left shoulder (163.815 on the left, 163.115 on the right as of today’s close). The tops of each of those shoulders (and accordingly the price move for the pattern to be complete) are 171.290 and 171.513, accordingly.

Final question: What does this mean for SPY? Well, I’m not totally sure. The trend between SPY and TLT, or any price trend really, isn’t an exact predictor of short-term movement. It’s also unclear to me whether TLT completing the HAS would indicate a longer trend reversal, or whether it would just have a small daily impact. That being said, the predicted move from ~163 to ~171, on the left shoulder, was met with a -12 change in SPY. If this is just the beginning of a more dramatic shift in TLT’s movement like on June 10th/11th, then the change could be bigger. In my mind, the important connection between SPY and this pattern’s completion is that it’s happening as SPY is just inches away from its ATH, meaning that the two could be reached at the same time, and TLT’s bullish reversal could be a bearish reversal for SPY, especially since we’re currently in a SPY overbought-TLT oversold range.

My bet is that SPY will rise this week a bit more, TLT will fall maybe a dollar more before they both reverse within the next two weeks. If I’m right, you should be watching the 10Y, 20Y, and 30Y bond yields this week. They’re likely to rise a little bit higher in the immediate future, so don’t jump in on any plays just yet. Watch the MACD on TLT for an indication that yield growth is stabilizing, and then wait for them to drop and TLT’s MACD to go positive + RSI to head above 30 as confirmation before you buy in (assuming that you want to play this on TLT and not with SPY puts or anything else). I think that TLT calls are probably the better way to go, since the pattern within TLT’s price action is a stronger indicator than the secondary correlation between that possible rise and the history between TLT and SPY.

TL;DR: Bonds look like they’re in for a comeback as SPY nears ATH, which could be spooky for equities. Maybe the rug pull? Idk, could be. You decide.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.

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