Sentiment Speaks: Are Bonds Warning Us?

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About: iShares 20+ Year Treasury Bond ETF (TLT), Includes: BIL, DFVL, DFVS, DLBS, DTUL, DTUS, DTYL, DTYS, EDV, EGF, FIBR, GBIL, GOVT, GSY, HYDD, IEF, IEI, ITE, PLW, PST, RISE, SCHO, SCHR, SHV, SHY, TAPR, TBF, TBT, TBX, TLH, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBT, UST, VGIT, VGLT, VGSH, VUSTX, ZROZ
by: Avi Gilburt
Summary

Bonds are likely heading higher in the last half of 2019.

The Fed will follow the bond market.

The Fed may be forced to lower rates as the bond market rallies into later this year.

Since I have been updating many of my expectations this week, I thought I would write a quick article on bonds too.

To recap where we have come from, we successfully called the top to the bond market back in 2016, and then re-entered the long side of the bond market when TLT dropped just below 113. Our initial expectation was for a rally to the 124 region, followed by a pullback, and then expected that we would rally next to at least the 128 region.

At the end of March, as we approached the 127 region, my charts highlighted the 126.70 region as the “ideal” target for wave 3 off the early March lows. You see, wave 3 of a 5-wave structure often targets the 1.618 extension of waves 1 and 2. And, that level was 126.70, with TLT striking a high of 126.69 before it turned down. That is why I personally exited all my leveraged positions (options) on TLT when we struck that level.

But, when the market broke below the .618 extension in the 124 region, it suggested that the market was not going to provide us a standard Fibonacci Pinball structure to the higher levels we expect. Moreover, when we break below the .618 extension, quite often we see a failure of the rally. So, I took a step back at that time, and reduced my positions in TLT.

At this point in time, the market is suggesting to me we may complete this last segment of the rally as an ending diagonal. Those are often quite overlapping and provide much volatility. That means that if the market now breaks back out over 126.70, it suggests that we are likely within that ending diagonal pattern, and we should expect volatility, with an upward bias to at least the 131 region, but with a more ideal target in the 135/36 region as we look towards the last half of 2019.

But, more importantly, what will this mean to the Fed?

As I have written many times before, I believe that the Fed follows the market and does not lead it. In fact, you can read my last article on the matter (The Fed Has Lost Control), as it explains this perspective using many historical examples.

So, in following up on this perspective, I am looking to what TLT is telling me in order to glean a direction for interest rates.

What all this means is that rates may be dropping as the market continues in the correction we expect in the equity market. It also means that the Fed will likely have its hand forced to lower rates, as the market will be leading it down that path.

I am also quite certain that most of the market will believe that the Fed’s lowering rates will “cause” the market to bottom out, as we begin our next major rally in the equity market towards our long term target over 3500SPX. But, a lot will depend upon the timing of the Fed action, as the market may still be completing its downside correction before that bottom is struck.

But, if you believe the Fed action will certainly cause a bottom to the stock market as it moves into its corrective phase, please consider carefully the words of Alan Greenspan when he noted:

“It's only when the markets are perceived to have exhausted themselves on the downside that they turn. Trying to prevent them from going down just merely prolongs the agony.”

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Disclosure: I am/we are long TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.