Selling TIPS, Buying Junk—What’s Next for Bonds

Feb. 10, 2011 10:46 AM ETIEF, HYG, JNK, TIP, PST

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Tom Aspray, professional trader and analyst was originally trained as a biochemist but began using his computer expertise to analyze the financial markets in the early 1980s. Mr. Aspray has written widely on technical analysis and has given over 60 presentations around the world. Many of the technical indicators that Mr. Aspray wrote about in the 1980s, such as the MACD, have since gained worldwide acceptance. Tom is regular contributor to Forbes where he writes a regular Week Ahead column. His expertise as a technical analyst has been acknowledged by the WSJ as well as some of the best known technical analysts.

It has been a rough five months in the bond market after the Treasury bond futures formed a negative “gravestone doji” at the end of August. This candle formation is often seen at major tops. The T-bond futures are down 14.2% from their highs while the iShares Barclays 7-10 Yr Treasury Bond Fund (IEF) topped out in October and is down almost 17%. Even the Treasury Inflation Protected Securities (OTCPK:TIPS) market has not been immune, as the iShares Barclays TIP Bond Fund (TIP) is down 6% while the high-yielding iShares iBoxx High Yield Corporate Bond Fund (HYG) is up 3.7% from the November lows. After the successful ten-year auction on Wednesday, the market is holding its breath for the 30-year auction later today, which may set up a trading opportunity.

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Chart Analysis: From a technical standpoint, the ProShares UltraShort Lehman 7-10 Year Treasury ETF (PST) looks better than the ProShares UltraShort Lehman 20+ Year Treasury ETF (TBT). The daily chart shows that PSP just completed a nice continuation pattern last week (boxed in blue) as PSP gapped to the upside and moved through its short-term downtrend.

The 50% retracement resistance now stands at $45.40 with the 61.8% resistance at $47.20
If the rally from the lows at point 3 is equal to the rally from point 1 to 2, the 100% equality target is at $48.20
The daily on-balance volume (OBV) has confirmed the recent breakout and is holding above support (line c) and its weighted moving average (WMA)
The lower close Wednesday could set the stage for another day or two on the downside
Initial support at $43.46 with the 20-day exponential moving average (EMA) at $42.71

What It Means: The technical action in the bond market suggests that a major trend change may have occurred, as the long-term downtrend in yields for the 30-year bond has been broken. In this week’s Trading Lesson, I’ll focus on the outlook for interest rates. To receive a copy, please sign up here.

How to Profit: This afternoon’s Treasury auction could push PST back to first good support. If PST has indeed formed a significant low, then the next rally should exceed the rally from $38.03 to $44.28. Traders should buy PST on a pullback to the $42.90-$43.34 area and place a protective stop at $41.36. On a move above $44.60, raise the stop to $42.90 and sell half the position at $45.21.