On a single day in August 1981, the US Treasury sold $4.5 billion worth of one-year T-Bills that carried a yield of 14.54%. About a month ago, the Treasury sold 90-day T-Bills at a yield of 0.0%. The 34-year bull market for Treasury securities was officially over. Unlike stocks, that have no upper limit on far they can rise, bonds can only move so far. Once yields reach zero, there is nowhere for them to go except up (and prices down).
Unfortunately, predicting the end of such a long-term trend is not as easy as what might be inferred from the paragraph above. In fact, bond analysts have been predicting (or declaring) that the end of the multi-decade bull market for bonds was imminent for the past seven years. The short-term interest rates controlled by the Federal Reserve have been at zero since December 2008. Given that the Fed can only take rates one direction from zero, it is easy to see why analysts have been warning of rising rates for seven years.
However, it is not that simple. Just like various stock market sectors do not always reach peaks and troughs in unison, various segments of the bond market also change directions at different times. Even within the US Treasury market, there could be years between the turning points for short-term and long-term maturity bonds. Three-month Treasury Bills hit 0.02% in December 2008. They didn’t stay there long, but in 2011, yields of 0.01% were commonplace. They moved higher for all of 2012, but the 0.01% level has been visited again many times over the past three years and it was 0.00% last month.
Given this action, where do you define the bottom? Was it that one day last month, or has it really been a seven-year bottoming process? Additionally, there is no guarantee it is over. There is always the possibility the lows could be visited again in 2016, 2017, or later. The process of identifying the turning point for one-year T-Bills gets easier. Their yields bottomed at 0.08% in September 2011 and are now above 0.50%.
Yields for 10-year Treasury securities bottomed in July 2012, while 30-year Treasury yields didn’t bottom until January of this year. All of these lows for yields translate to peaks for bond prices. Therefore, the bull market for 10-year Treasury bonds ended three years ago, while 30-year bonds enjoyed another couple of years. Investment-grade corporate bonds appear to have peaked in January of this year, while their high-yield (“junk”) counterparts topped out six months earlier. International bonds are another story, but their returns have been dictated more by currency fluctuations than yield changes the past few years. Each bond segment is interest-rate driven, but each also has its unique characteristics.
After the release of the employment reports last Friday, bond yields moved noticeably higher. It seems the market believes the economy is strong enough for the Fed to raise interest rates for the first time in nine years at its December meeting. As for bond ETFs and mutual funds, short-term funds can take advantage of higher yields as their holdings mature and are rolled over into new higher yielding issues. Long-term funds do not have that luxury and will have to endure price declines for many years. Vanguard Extended Duration Treasury (EDV) dropped 2% on Friday and is off about 5% so far this month. If you haven’t already reduced your exposure to rising interest rates, now might be a good time.
Technology maintained its first-place ranking and extended its lead over the other sectors. Consumer Discretionary is in the #2 spot for a second week, although Financials climbed up from sixth to form a virtual tie. Industrials moved two spots higher, giving the top of the rankings a completely different complexion than a month ago. The bottom has also changed, with the former leaders of Utilities, Real Estate, and Consumer Staples now sitting at the other extreme. Additionally, Utilities and Real Estate both slipped back into the red this week. This has been a rapid sector rotation, and it remains to be seen if the new alignment is sustainable. Another big change for the week was the rise of Health Care. After five weeks in last place, the sector jumped four places higher. This was accomplished with a four-point decline in its momentum score, but relatively speaking, its momentum decline was milder than that of the sectors that fell lower.
The top of the style rankings is unchanged this week. Large capitalization continues to be the dominant factor with Mega-Cap at the helm, followed by Large-Cap Growth, Large-Cap Blend, and Large-Cap Value. The remainder of the style categories underwent a significant shake-up over the past week. For the past month or so, the capitalization dominance continued throughout the rankings with Mid-Caps holding the middle ground and Small-Caps on the bottom. These lower groups reversed positions this week as Small-Cap Value, Small-Cap Blend, Small-Cap Growth, and Micro-Cap all posted momentum improvements and moved ahead of the Mid-Caps. The three Mid-Cap categories were not up to the challenge. They all posted declines in their momentum scores and dropped to the bottom of the rankings with Mid-Cap Value now in last place.
Four more global categories moved into the red this week, bringing the count of negatively trending global groups to seven. The four categories remaining in the green are the same four that were at the top last week, although their relative order has shifted. The US held onto the top spot, and China kept its third-place ranking while Japan and World Equity swapped places. Japan was able to climb two spots by holding its momentum score steady as the other categories posted declines. The lower seven are in the same order as a week ago, and the four dropping into the red are the Eurozone, EAFE, the UK, and Emerging Markets. The three categories at the bottom all saw large momentum declines, and they continue to lag far behind the others.
“We want to get it over with, get a fresh start to the year, no pent up expectations. In fact, if they don’t do it in December then January would be volatile.”
–Stephen Jen, Managing Partner at SLJ Macro Partners, London, talking about a Fed interest rate hike and its impact on currency markets
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