Over the past few weeks, the bond market has taken off, and oddly, the stock market has too. Usually, the bond market rallies when the stock market comes under pressure, because the bond market is where investors flock when they perceive risk, but that did not happen recently. This has some theorists in a conundrum, but it presents excellent trading opportunities too.
First, let's address the conundrum, the extended move in the bond market recently. The long-term U.S. Treasury bond has been rallying while the stock market makes all-time highs, and that concerns smart money. This divergence is due to the deteriorating state of the US economy on a naturalized basis, as that is defined by the Investment Rate, even though the economy looks good on the surface, and eventually, the stock market will reflect the risks that the bond market is already warning us about, but again, trading opportunities can surface, and in both directions.
Although the underlying macro economic conditions are deteriorating, and although there are serious risks that the bond market, which is largely comprised of long-term investors who are much more diligent in their research, is warning us about, our observations also suggested that the bond market had increased more than it should have.
In no way does this imply that the bond market is going to crumble, in fact, our combined analysis suggests that bonds may still be in high demand as the progression towards the natural state of the economy continues and the Net Real Stimulus (NRS) offered by the combined efforts of the Federal reserve and the U.S. treasury continue to drain liquidity from the economy, but immediately and in conjunction with opportunistic trading signals, the short side of the long-term U.S. treasury bond has been appealing.
Specifically, last Thursday, the ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) tested the longer-term support level we identified in our real-time trading report for TBT. At the same time, the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT), which is not double-weighted, also tested the resistance level that we offer in our real-time trading report for TLT. This told us that not only have the long-term U.S. Treasury bonds tested a level of resistance, but the double short ETF for the long-term U.S. Treasury bonds tested its respective support level too.
This presented an opportunity to trade the long-term U.S. Treasury bonds short from last Friday. Since then, TBT is up about 5%, which is a very nice short-term gain and directly in line with our objective for the trade. We recognized that an exaggeration happened, we recognized tests of resistance and support in these ETFs as well, and those were trading catalysts that influenced the decision to short the long-term U.S. Treasury bonds for the past few days.
Because we believe the macroeconomic risks are real, we have already taken profits.
The underlying macro economic conditions suggest that risks are high, the bond market has historically been much smarter than the stock market, and Net Real Stimulus is already net negative and set to become even more of a drain on liquidity in the financial system, and we believe the divergence between the stock market and the bond market in recent weeks reflects the financial community's perception of risk, as that relates directly to overall liquidity concerns too.
Fathomably, we would not be opposed to buying TLT when the time is right too.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: By Thomas H. Kee Jr. for Stock Traders Daily and neither receive compensation from the publicly traded companies listed herein for writing this article.