For most of the past twelve years, the trend in yields on U.S. government bonds have roughly correlated with equity prices as higher yields reflected improved economic growth expectations, and lower yields reflected concerns of slowing growth. In the past few weeks this relationship has changed. Higher yields are beginning to reflect investor concerns of inflation. This is why the yield on the 30-year U.S. Treasury began to rise on August 25, 2010, forty-four days before the yield on the 10-year bond bottomed. We believe this is a temporary phenomenon that will eventually revert back to the norm of the past decade. Fears of sharply rising interest rates are misplaced. These unfounded fears suggest that the bull market in bonds end in a sharp reversal more often associated with bear market bottoms
Most investors are aware that equities form bull market tops in a different manner than they typically bottom. A bear market bottom is often an emotional event represented by a sharp reversal and eventual retest. The topping process, on the other hand, usually takes more time. It is typically defined by a period of distribution that is proportional in time to the length of bull market that is ending. This why it is often said that market bottoms are an event, and market tops a process. This behavior at tops and bottoms is a “human behavior” that is not specific to equities. Historically, tops and bottoms in the bond market follow the same pattern.
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US Treasury Long Bond Yield Monthly -- Inverted Scale
Above is a chart of the U.S. Government Long Bond that goes back to 1919. The scale is inverted so that the chart pattern reflects the trend of bond prices rather than yields. It’s apparent that bond prices have been rising since October, 1982. That particular month is ingrained in my psyche because it is the month I purchased, and financed, my first new car. Needless to say, it was a long term peak in interest rates and a bear market bottom in the bond market. The bottoming of bond prices was a sharp and emotional event, retested three years later. Contrast this to the topping process of bond prices in the 1940’s.
The January, 1941 top price in the bond market was the peak of a bull market in bond prices that started in January of 1921. The twenty-year bull market saw interest rates decline from a high of 5.90% to 1.95%. From the above chart, it can be seen that although the peak in bond prices occurred in 1941, it required a full decade of distribution before the bear market trend took hold. Granted, that particular distribution top required a long period of time relative to the bull market and historically norms, but the point is that long-term bull markets do not typically reverse as sharply as they bear markets bottom.
It is because of this, that we expect long-term U.S. Treasury to undergo a multi-year period of distribution prior to any bear market trend taking hold. It may be that the December, ’08 low in interest rates is the low in yields that will hold for decades. Or, a new low, sub 2.00% similar to the 1940’s could be in our future. We don’t know. But it is unlikely that U.S. Treasury yields will simply reverse a multi-decade trend without a prolonged period of distribution. For now, investors are still buying bonds as they search for alternatives to the risks of the equity market. The bond market still appears to be under accumulation, not distribution.
Disclosure: No positions