Bond Market Downturn Is As Inevitable As Fed Tapering

Includes: TLT
by: Andrew_Keene

Equity markets continue to face uncertainty in the wake of the Federal Reserve's announcement regarding the imminent (relative to apparent expectations) cutback in open-market bond purchases, though there has developed a bullish trend in stocks. The relative strength of equities has brought value-storage instrument markets to their knees, to the point that long-term U.S. Treasury bonds and precious metals look dead in the water. Yields have been driven up amidst the sell-off at a rate not seen in a decade; last week the rate jumped .4% on the 10-year and this momentum has followed through into recent sessions, as further gains brought yields well above 2.6% on the highs. The global bond market at this point seems poised for a down year for only the first time since 1999. The iShares Barclays 20+ Year Treasury Bond ETF (TLT) has erased medium-term gains and is trading below $110, weakening again after rebound following Wednesday's GDP number, down from a year-to-date high over $124 on May 1st. There is a notable reluctance among investors to buy into the bond market at this point despite sentiments expressed by several institutions suggesting that this week's downtrend is merely a dip.

It isn't only an institutional bias towards the bond market that could indicate that the present valuation of bonds and bond-based derivatives have reached, or are approaching, a low. Shares of TLT entered oversold territory, as measured by the relative strength index, on the 21st of this month. The stock showed a reading of 29.86 on that day, .14 below the 'Oversold' cutoff. Including that day, the stock has been in oversold territory for three of the last 5 trading days, and today's gains mark the highest rating since the 19th; RSI is currently sitting at ≈34.43. Despite the relatively high rating, TLT shares look to continue the trend seen over the past 3 days of the ETF's rally, with shares closing consistently lower than their elevated opening price.

Even on those days in which the rating has broken above the "oversold" cut-off, there has been little upward correction in the price of TLT shares. This evidence suggests that the rabid short-side interest is less motivated by short-term panic than by long-term and fundamental evidence of a downturn in the bond market. Even recent buy-ins (and positive commentary) by figures such as PIMCO's Bill Gross have done little to reassure bond buyers that the market will rebound. Gross and Laszlo Birinyi, President of Birinyi Associates, Inc., made fairly bullish statements on the state of the bond market in separate interviews on the 19th of June.

Economic data releases in recent days have largely supported equity markets over treasuries and will, for the most part, continue to provide vindication for Ben Bernanke's current timetable for reductions in treasury purchases by the central bank. Homebuilding and home sales, as well as durable goods orders, rose at an unexpectedly high pace in the last period, providing incentive for investors to buy-in to higher risk equities markets and shy away from the exploding yields of treasuries further, generating further depression in bond prices. Wednesday's release of GDP data produced a potential long setup, but this opportunity went sour as Thursday's jobs data quashed much hope of any long-term bond rally. Even the Federal Reserve's backtracking on the press conference content has been ineffectual in closing the floodgates, as conflicting views from the New York and Richmond chiefs have largely cancelled each other out and the market has not made any notable gains.

Despite a strong upward push on Friday, TLT has begun this week on a low note and looks likely to move lower in the wake of yet more positive economic data. The market seems unwilling to accept the current valuation of long-term bonds. In the struggle between bullish and bearish factions over these instruments in the coming weeks it would appear that the latter has the upper hand in fundamental and technical support. The Fed exit is inevitable, and once details become clearer and unless this decline in demand is priced in prior to the event, it will cause a further and unavoidable downtrend in bond market demand and liquidity. Yields are nestled against inflation at this point in time, and will be driven higher in a post-QE world as investors seek greater returns amidst healthier economic circumstances.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.