U.S. Treasury Bonds Have A Rendezvous With Destiny

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Includes: EDV, IEF, TLH, TLO, TLT, VGLT, WHOSX
by: Kevin Wilson

Summary

Bond yields have declined for over 30 years, first due to disinflation after peak yields were reached in the early 1980s, and then due to the debt-deflation cycle since 2008.

The historical pattern for U.S. 10-Yr. bond yields follows a well-defined channel that has not been violated (on the upside) in many years.

Comparison of the Japanese ($JPT10Y), German ($DET10Y), and U.S. ($TNX) 10-Yr. yield trends shows a close correlation over time; the U.S. 10-yr. yield may drop as low as 1.00%.

The implication is that bond funds like WHOSX, EDV, VGLT, TLT, TLH, TLO, and IEF will continue to outperform in 2016 as markets continue to deteriorate.

Well-known economist Lacy Hunt has been calling for lower bond yields for many years, and he has been right. In part his belief in lower yields on the long bond over time was based on the disinflation trend after the 1981 peak in yields. But more recently his belief in lower yields over time was based on the observation that debt-deflation cycles like the one in Japan (starting in 1989) tend to follow the same pattern, no matter which country or decade the trouble started in. Economist Gary Shilling has also made that call, favoring 30-year zero coupon bonds for many years now.

Source: Lacy Hunt, Hoisington Research

Analyst Doug Short has long noted the downward trend in the U.S. 10-year Treasury yield, and although we are now near the bottom of his chart's long-term trend channel, we are still very much on track.

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Last December I suggested that bonds would outperform in 2016 based on these patterns and the situation in the economy and markets. So far in 2016 the longer term Treasuries have outperformed nicely. For example, the i-Shares 20+ year Treasury ETF (NYSEARCA:TLT) has returned 8.56% YTD, compared to -5.86% for the S & P 500 (SPX). This is very good, but you'd expect some extra juice in a bond trade during a substantial sell-off in the stock market. What will happen over the intermediate term, assuming we are not in a secular bear market? Below we chart the trends observed for the German 10-Yr. ($DET10Y), the Japanese 10-Yr. ($JPT10Y), and the U.S. 10-Yr. ($TNX). It is clear that the long-term pattern continues, but note that the recent yields on the foreign government bonds showed a wide spread to the 10-Yr. U.S. Treasury. The latest spread to German bunds is about 1.54%, and the latest spread to Japanese JGBs is about 1.73%.

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The implications are two-fold: 1) foreign investors will continue to move assets to the U.S. bond market in search of higher yields, thus driving those yields lower and prices higher; and 2) The long-term trend toward zero yields (ZIRP) or even negative yields (NIRP) is intact and will likely continue. How low will U.S. yields go? I don't know of course, but it would be consistent with the data, with the historical trends, and with the current economic and market uncertainty to see those rates fall all the way to 1% or lower, yet this year. This call has been made before, by eminent analysts like Jeffrey Gundlach and Lacy Hunt, but many still don't think it can happen. Because most don't believe it, I think big money could yet be made on the longer term bond funds (e.g., WHOSX, EDV, VGLT, TLT, TLH, TLO, and IEF). I intend to capture some of that as the global situation continues to deteriorate.

Disclosure: I am/we are long TLT, VGLT, IEF.

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.

Additional disclosure: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks or other securities mentioned or recommended.