Seeking Alpha
Long/short equity, dividend investing, ETF investing, dividend growth investing
Profile| Send Message|
( followers)  

Summary

  • EDV has increased over 25% this year.
  • EDV is dependent on long-term rates.
  • It is hard to predict interest rates to predict where EDV is.

Vanguard Extended Duration Treasury ETF (NYSEARCA:EDV) is a very specific ETF. It only invests in 20-to-30 year Treasury bond strips. This is a derivative that takes the coupon payments from government bonds and sells them as individual zero coupon bonds. These strips have no default risk, and usually sell at a high discount. It's good for people who are looking for a steady stream of income at certain points in the future.

This year, EDV has been on a roll. Looking at the Yahoo Finance graph below, EDV has increased over 25%. This is a nice return in only eight months.

(click to enlarge)

Why has EDV taken off this year? One reason is that long-term rates have decreased. The simple rule to follow is that when rates decrease, bond prices increase. The graph below shows the daily yield curve rates for the 20- and 30-year bonds. This was taken straight from the treasury website here. The rates started out over 1.2%, and now have dropped to under .9%. Compare that to the graph above, you will see the price of EDV increase from $90 to $112. There is a negative correlation between the rates and price.

(click to enlarge)

There is more evidence on the graph below that shows this. Below is the weekly percentage change on the treasury rates and the price of EDV. Any time the interest rates increase, you see a corresponding decrease in EDV.

(click to enlarge)

The yield curve usually moves with the state of the economy. The Dow Jones is supposed to be an indicator of how well companies are doing in current economic conditions. I am going to see if EDV is correlated to the Dow Jones. The Yahoo Finance graph below shows the Dow and EDV together. It looks like the prices move opposite of each other as well.

(click to enlarge)

The graph below is the weekly price percent change for the Dow and EDV. You can see the negative correlation more clearly.

(click to enlarge)

From this analysis, we can conclude that EDV is dependent on and will move in the opposite direction of the long-term yield curve and Dow Jones. One can also deduce that interest rates and the Dow Jones coincide with each other. This makes sense. When the economy does well, GDP rises. Investors will flock to riskier investments, and the Dow will rise. Inflation and interest rates will rise too. This will cause bonds prices to decrease. When economic times are tough, investors are taking money out of stocks and into safer investments. This will cause the Dow to drop. The government will lower rates to spur lending and spending. When this happens, bond prices will increase.

It's easy to look over the past 8 months and say "see what happened, see the correlation." You can't make money on the past. If you know the correlation exists, the hard part is predicting where rates will go. One thing that can help is to listen to what Fed Chair Janet Yellen has to say at the monthly Federal Treasury meeting. Bond prices fluctuate around the days surrounding these meetings, and this could create a good entry point. At the last meeting in July, she said, "The Fed may raise interest rates sooner than expected if the recovery in the US labor market is sustained." This is an obvious statement, as investors already know this. What they really want to know is a specific time frame of when this will happen. The Fed really never knows. They can make predictions, but the Fed's actions usually lag to what is happening in real-time as economic data lags. Just by definition, the Fed doesn't know if the U.S. is in a recession until months down the road, so they won't lower rates until after the fact. There are times when it's easy to predict what the Fed will do. When the financial crisis hit, the Fed dropped rates away. Most of the time, the answer isn't going to be this clear. It will take a lot of investigating to figure out what will happen.

So far this year, we have seen rates decrease. The Dow has had its ups and downs, but is only up 1.3% this year. With these two metrics staying depressed, investors have driven EDV to a 25% gain and a 52-week high. Is EDV going to continue to reach new highs, or will Fed Chair Yellen pop the bubble? Investors won't be able to do anything until they invest. This could be an investment for protection against future recessions, or a trading play on the changing interest rate environment. I have been trading it up all the way to its current price. A buy and hold strategy would have worked better, but I wouldn't have expected rates to keep dropping and the price to continue going up.

Source: Vanguard Extended Duration Treasury ETF - Taking Advantage Of Low Rates