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Eyes On Income

|Includes: iShares iBoxx $ High Yield Corporate Bond ETF (HYG), JNK

I have been following the bond market since 1982, which was just a year after the yield on the 30-year bond peaked at 15.20%. In the early 1990s, I was pleased to be noted by the Wall Street Journal as "one of the top bond market technicians."

The decline in yields and the rise in bond prices over the past 32 years have been dramatic, but there have been other long-term trends in rates. In fact, the decline in yields was equal in time and price to the rise in bond yields and decline in their prices that took place from the early 1950s until 1981.

It has been my view since earlier in the year that the next two years are likely to be pivotal for the bond markets. Therefore, it will be increasingly important for income investors to keep an eye on rates as they will need to be a bit more active in the management of their income portfolio.

The outlook for both the 30-year T-bond and 10-Year T-note yields has reached an interesting juncture, so now I believe is a good time to formally introduce an income-only portfolio.

In the past, I have recommended high-yielding stocks for the Charts In Play portfolio that also had growth potential. However I have recommended selling them when nice profits were attained or if the technical outlook changed.

For the Eyes on Income portfolio, I will only sell the income holdings if there is a significant change in my outlook for rates. Let's look at the key levels to watch.


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Key Yields to Watch: Though the yield on the 10-year T-note is more relevant for consumers, I still find that the 30-year T-bond yield (TYX) can provide valuable insight into where rates are headed.

  • The weekly chart of T-bond yields shows that in late 2011, yields declined to the 2.855% level before rallying to just over 3.47% in March 2012.
  • Then yields plunged over the next four months to a low of 2.517% in July, which is labeled as the head of a reverse head and shoulders bottom formation.
  • The rally from last summer's low hit a high of 3.284% in early March before yields again dropped back to the 2.855% level at the end of April.
  • Over the past three weeks, yields have closed higher and as of May 23 look ready to close higher for the fourth week in a row.
  • The neckline of the reverse H&S bottom is just above this week's high at 3.241% and a weekly close above 3.284% will complete the formation.
  • The upside target from the H&S formation is in the 4% area.

The chart of T-note yields (TNX) also reveals an apparent reverse H&S formation but the neckline level is less clear. The left shoulder (LS) was formed in September 2011 at 1.696%.

  • The initial rally hit a high of 2.407% before yields again dropped to the 1.800% level in early 2012.
  • The secondary high in March was at 2.363% before yields dropped to a low of 1.394% in July 2012, forming the head of the H&S formation.
  • The TNX yield reached a high of 2.064% the week ending March 12 before turning lower.
  • The decline in yields broke the uptrend but held above the November lows at 1.556%.
  • Last week, yields again rose above 2.00% and a weekly close above the March high (2.064%) will signal a rally to the major resistance at 2.390%.
  • This connects the prior twin peaks at 2.407% and 2.363%.

chart
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The potential bottoming formation in the weekly charts of both the T-bond and 10-year yields must be viewed in the context of the longer-term trends. The daily and weekly trend in yields is currently up, but the monthly charts tell a different story.

  • The monthly chart goes back to 1990, and since 2000, the downtrend in yields, line a, is well established.
  • On the monthly chart, there is next major resistance in the 3.525-3.3563% area. This corresponds to the declining 20-month EMA and the lows from August 2010.
  • This long-term downtrend is now at 4.181%, which is just above the upside target from the reverse H&S formation on the weekly chart.
  • The monthly charts make it clear that yields have to move significantly higher before it is clear that the long-term trend has changed.

Featured Investment: For part of one's income portfolio, I like a bond fund that holds income instruments with shorter duration (one-eight years) as it will provide more flexibility if rates move higher and also if they stay in a broad range.

DoubleLine Total Return Fund (DLTNX) has a current yield of 5.22%, which is paid on a monthly basis.

The fund details (from eTrade.com) show that it has $40.7 billion in assets with an expense ratio of 0.76% and a minimal investment of $2,000. The expense ratio is a bit higher than some of the high-yield ETFs, but it is below average for the class of funds.

The weekly chart of DLTNX shows that it is likely to close the week below the 20-week EMA at $11.38 as it closed Thursday May 23 at $11.36.

The major price support is in the $11.25 to $11.34 area. In 2012, DLTNX had a low of $11.02 while it hit a low of $10.80 in 2011.

Income Strategy: The weekly OBV on two of the largest junk bond ETFs, SPDR Barclays High Yield Bond (JNK) and iShares iBoxx $ High Yield Corporate Bond (HYG) turned negative this week.

This action is consistent with my short-term view that rates will move higher as we start the summer. If the reverse H&S bottom formations are completed in either T-bond or T-note yields, then a new report will be released.

Portfolio Recommendation: Based on a $100,000 portfolio, invest $1,000 in DLTNX on May 28 and then $1,000 on the next three Mondays. If the fund has a daily close at $11.34 or lower, invest another $3,000. Then, if the fund closes at $11.30 or lower, add another $3,000 in the fund. The goal is to eventually invest $10,000 or 10% of your income portfolio.

Future investments for the Eyes on Income portfolio will be primarily focused on individual stocks or other income-producing instruments, including ETFs.

To get Tom's review of last week's market action see The Week Ahead

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.