The “barbell” approach to bond investing typically involves buying a long-term bond fund or ETF and a short-term bond fund or ETF. The idea is that the long-term component provides the upside potential while the short-term component dampens overall volatility and “smooths” the equity curve. This article is not intended to examine the relative pros and cons of this approach. The purpose is to consider an alternative for the years ahead.
The Current Situation
Interest rates bottomed out several years ago and rose significantly from mid-2016 into late 2018. Just when everyone (OK, roughly defined as “at least myself”) assumed that “rates were about to establish an uptrend” – rates topped in late 2018 and have fallen off since. Figure 1 displays ticker TYX (the 30-year treasury yield x 10) so you can see for yourself.
In terms of the bigger picture, rates have showed a historical tendency to move in 30-year waves. If that tendency persists then rates should begin to rise off the lows in recent years in a more meaningful way. See Figure 2.Figure 2 – 60-year wave in interest rates (Courtesy: www.mcoscillator.com)
Will this happen? No one can say for sure. Here is what we do know: If rates decline, long-term treasuries will perform well (as long-term bonds react inversely to the trend in yields) and if rates rise then long-term bond holders stand to get hurt.
So here is an alternative idea for consideration – a bond “barbell” that includes:
*Long-term treasuries (example: ticker VUSTX)
*Floating rate bonds (example: ticker FFRAX)
Just as treasuries rise when rates fall and vice versa, floating rate bonds tend to rise when rates rise and to fall when rates fall, i.e., (and please excuse the use of the following technical terms) when one “zigs” the other “zags”. For the record, VUSTX and FFRAX have a monthly correlation of -0.29, meaning they have an inverse correlation.
Figure 3 displays the growth of $1,000 invested separately in VUSTX and FFRAX since FFRAX started trading in 2000. As you can see the two funds have “unique” equity curves.
Figure 3 – Growth of $1,00 invested in VUSTX and FFRAX separately
Now let’s assume that every year on December 31st we split the money 50/50 between long-term treasuries and floating rate bonds. This combined equity curve appears in Figure 4.
Figure 4 – Growth of $1,000 50/50 VUSTX/FFRAX; rebalanced annually
Since 2000, long-treasuries have made the most money. This is because interest rates declined significantly for most of that period. If interest rise in the future, long-term treasuries will be expected to perform much more poorly. However, floating rate bonds should prosper in such an environment.
Figure 5 displays some relevant facts and figures.
Figure 5 – Relevant performance Figures
The key things to note in Figure 5 are:
*The worst 12-month period for VUSTX was -13.5% and the worst 12-month period for FFRAX was -17.1%. However, when the two funds are traded together the worst 12-month period was just -5.0%.
*The maximum drawdown for VUSTX was -16.7% and the maximum drawdown for FFRAX was -18.2%. However, when the two funds are traded together the worst 12-month period was just -8.6%.
Summary
The “portfolio” discussed herein is NOT a recommendation, it is merely “food for thought”. If nothing else, combining two sectors of the “bond world” that are very different (one reacts well to falling rates and the other reacts well to rising rates) certainly appears to reduce the overall volatility.
My opinion is that interest rates will rise in the years ahead and that long-term bonds are a dangerous place to be. While my default belief is that investors should avoid long-term bonds during a rising rate environment, the test conducted here suggests that there might be ways for holders of long-term bonds to mitigate some of their interest rate risk without selling their long-term bonds.
Like I said, food for thought.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
Stephen Hill is President of AIQ Systems. For the past 15 years he has been involved in all aspects of AIQ Systems, from support and sales to programming and education. Steve is a frequent speaker at events in the U.S. and Europe, talking on subjects as diverse as Portfolio Simulation Techniques, Advanced Chart Pattern Analysis and Trading System Design.
Chart pattern analysis, often thought of as part science part art is a key element in many traders decision process. Common patterns like double tops and bottoms are somewhat self-fulfilling, given that most of us can see these patterns occurring. Measures of what consititues a double top or bottom in good analytical terms we’ll save for another article. In this this article we are focussing on two of my favorite chart patterns; Flags and Pennants
Flags and Pennants are Consolidation or Continuation Patterns
These patterns break out in the direction of the previous trend, confirming the existing trend, suggesting that investors are considering whether the market is overbought or oversold but ultimately deciding to confirm the existing trend. Flags and pennants are of two types, bullish or bearish
Flags and pennants are generally considered continuation patterns as they breakout in the prevailing trend direction. They represent a brief pause especially after a steep run up in an active ticker. They are a fairly common and useful for short term trading.
Bullish Flags – formation
Lower tops and lower bottoms bounded by two parallel trendlines with pattern slanting against the prevailing trend are considered bull flags (figure 1).
Figure 1. Bullish flag pattern
Bearish Flags – formation
Higher tops and higher bottoms bounded by two parallel trendlines with pattern slanting against the prevailing trend are considered bear flags. (figure 2).
Figure 2. Bearish flag pattern
Elements of bullish flags
A rapid and steep price rise of around 20% from bottom of the pole to top.
Decreasing volume during the formation of the flag.
Breakout occurs to the upside with resumption of increase volume levels
Flags length excluding the pole classic should be around 10 days, can be less but not more than 20 days.
Figure 3. Whole Foods Market, Inc (WFMI) bullish flag
Bulkowski noted that the high and tight flag performed best. (source Encyclodpedia of Chart Patterns by Thomas Bulkowski). 2Some 25% of the patterns are horizontal notes Markos Katsanos. (source Measuring Flags & Pennants: Technical Analysis of Stocks and Commodities vol 23 no 4)bullish flag breakout on increased volume note the pole length is 20% + of the price action and the diminishing volume on the flag.
Elements of bearish flags
A rapid and steep price decline of around 20% from top of the pole to bottom.
Decreasing volume during the formation of the flag.
Breakout occurs to the downside with resumption of increase volume levels.
Flag length excluding the pole should be around 10 days, can be less but not more than 20 days.
Figure 4 shows MNST classic bearish flag breakout on increased volume note the pole length is 20% + of the price action and the diminishing volume on the flag.
Bullish Pennants – formation
Pennants look very much like symmetrical triangles, on the end of a pole, typically they are smaller in size and duration (figure 5).
Bearish Pennants – formation
An upside down bullish pennant, the triangle is at the bottom of the pole. (figure 6).
Elements of bullish pennants
A rapid and steep price rise of around 20% from bottom of the pole to top.
Decreasing volume during the formation of the pennant.
Pennants look like symmetrical triangles on a pole, price action is converging.
Diminishing volume as pennant forms.
Breakout to the upside with re- sumption of volume levels.
Pennant length excluding the pole should be around 10 days, can be less but not more than 20 days.Figure 7 shows CDW classic bullish pennant breakout on increased volume
A rapid and steep price drop of around 20% from top of the pole to bottom.
Decreasing volume during the formation of the pennant.
Pennants look like symmetrical triangles on a pole, price action is converging.
Diminishing volume as pennant forms.
Breakout to the downside with resumption of volume levels.
Pennant length excluding the pole should be around 10 days, can be less but not more than 20 days.
How do you trade flags and pennants?
Katsanos study of Flags and pennants revealed that the average breakout was 45% over an average period of 11 days. Bulkowski noted a 63% average gain. to trade these breakouts, set tight stops at low of day before breakout and use trailing stops once breakout occurs.
Target prices are more difficult to predict as these are continuation patterns, but after 11 days you are beyond the average move in days.
AIQ tip
Once a breakout occurs, use AIQ space on right of the chart (rtalerts only) and advance 11 days into the future. Draw a trendline parallel to the pole trend from the breakout point.
2018 witnessed something of a “fake out” in the bond market. After bottoming out in mid-2016 interest rates finally started to “breakout” to new multi-year highs in mid to late 2018. Then just as suddenly, rates dropped back down.
Figure 1 displays the tendency of interest rates to move in 60-year waves – 30 years up, 30 years down. The history in this chart suggests that the next major move in interest rates should be higher.Figure 1 – 60-year wave in interest rates (Courtesy: www.mcoscillator.com)
A Way to Track the Long-Term Trend in Rates
Ticker TNX is an index that tracks the yield on 10-year treasury notes (x10). Figure 2 displays this index with a 120-month exponential moving average overlaid. Think of it essentially as a smoothed 10-year average.
Figure 2 – Ticker TNX with 120-month EMA (Courtesy AIQ TradingExpert)
Interpretation is pretty darn simple. If the month-end value for TNX is:
*Above the 120mo EMA then the trend in rates is UP (i.e., bearish for bonds)
*Below the 120mo EMA then the trend in rates is DOWN (i.e., bullish for bonds)
Figure 3 displays 10-year yields since 1900 with the 120mo EMA overlaid. As you can see, rates tend to move in long-term waves.
Figure 3 – 10-year yield since 1900 with 120-month exponential moving average
Two key things to note:
*This simple measure does a good job of identifying the major trend in interest rates
*It will NEVER pick the top or bottom in rates AND it WILL get whipsawed from time to time (ala 2018).
*Rates were in a continuous uptrend from 1950 to mid-1985 and were in a downtrend form 1985 until the 2018 whipsaw.
*As you can see in Figure 2, it would not take much of a rise in rates to flip the indicator back to an “uptrend”.
With those thoughts in mind, Figure 4 displays the cumulative up or down movement in 10-year yields when, a) rates are in an uptrend (blue) versus when rates are in a downtrend (orange).
Figure 4 – Cumulative move in 10-year yields if interest rate trend is UP (blue) or DOWN (orange)
You can see the large rise in rates from the 1950’s into the 1980’s in the blue line as well as the long-term decline in rates since that time in the orange line. You can also see the recent whipsaw at the far right of the blue line.
Summary
Where do rates go from here? It beats me. As long as the 10-year yield holds below its long-term average I for one will give the bond bull the benefit of the doubt. But when the day comes that 10-year yields move decisively above their long-term average it will be essential for bond investors to alter their thinking from the mindset of the past 30+ years, as in that environment, long-term bonds will be a difficult place to be.
And that won’t be easy, as old habits die hard.
Figure 5 is from this article from BetterBuyandHold.com and displays the project returns for short, intermediate and long term bonds if rates were to reverse the decline in rates since 1982.Figure 5 – Projected total return for short, intermediate and long-term treasuries if rates reverse decline in rate of past 30+ years (Courtesy: BetterBuyandHold.com)
When rates finally do establish a new rising trend, short-tern and intermediate term bonds will be the place to be. When that day will come is anyone’s guess. But the 10-year yield/120mo EMA method at least we have an objective way to identify the trend shortly after the fact.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
2019 has rewarded us with average portfolio returns in a Moderate portfolio category between 8-14% so far since January 1, 2019*. A Moderate portfolio is a mutual fund portfolio with approximately 50-60% stocks and 30-40% bonds.
MARKET RECAP:
Since last month my computer models see the trends of the stock markets as Somewhat Cautious. Most of the sectors of the markets are at or near the old high of last September except:
The healthcare sector is down 7% from last year’s high
The small-cap sector is down 7%
The midcap sector is down 3% and a few more.However, overall, the indexes are at or near their old high, and this is where we need to address as to whether the markets will breakout or top out here and head lower. With the markets up so much from the lows in December, stocks are overdue for some consolidation following the major rally this year and at its old highs of last September**.
**See charts below as to whether the markets are overvalued and could sell off or continue to rise.
Where do we stand from an economic stance?
The economy is still doing well:
Job growth is outstanding with 263,000 new jobs created last month
Unemployment at 3.6% is the lowest it has been in decades, and most economic measures are overall healthy.
The tax reduction to corporations is making earnings rise
The USA is enjoying the best overall economy in the world currently.Most of the economic surveys conducted suggested that the main problem with the markets is uncertainty with trade with China. The uncertainty could positively drop the markets down if the Trade War is not resolved in a positive outcome. Our economy has risen on an overall uptrend for about ten years, and it is overdue for a recession sometime over the next 1.5 to 3 years, but nothing seems to be on the horizon in the very near future.
Interest rates remain relatively stable, and the most likely near-term outlook is for continued stability.
Index Averages
Some of the INDEXES of the markets both equities and interest rates are below. The source is Morningstar.com up until May 4, 2019. These are passive indexes.
*Dow Jones
+13.57%
S&P 500
+17.59%
NASDAQ Aggressive growth
+22.20%
I Shares Russell 2000 ETF (IWM) Small cap
+20.10%
International Index (MSCI – EAFE ex USA)
+13.10%
Moderate Mutual Fund
+10.20%
Investment Grade Bonds (AAA)
+4.88%
High Yield Merrill Lynch High Yield Index
+7.68%
Floating Rate Bond Index
+5.17%
Fixed Bond Yields (10 year)
+2.55% yield
The average Moderate Fund is up 10.2% this year fully invested as a 60% in stocks and 40% in bonds.*Explanation of each on the last page
If interest rates are peaking and look to be flattening or declining over the next year then investment grade or multisector bonds technically might be better than floating rate bonds. But diversification is important.
Source: AIQ TradingExpert Pro
The S&P is above. Notice the trend line in white. The technical indicators are Somewhat Cautious, in addition, this is not a time to add a good deal of money to the market. If you can see the white horizontal line at the top of the picture you will see that it corresponds with the high hit last September in the market. The old high hit on May 1, 2019 of 2954 intraday has to be broken through with a lot of volume or the S&P 500 could start to rollover. IMPORTANT, If 2904 is broken on close I will be getting more Cautious, if it closes below 2886, I will be getting Very Cautious as it would have clearly broken the 2019 Trend line. At that point, there would be some Buying support at 2852 its 50 day moving average.
The next graph underneath the S&P 500 shows the Momentum of the market is flattening out. This is also an indicator that the market is still good, but losing a little of the upside momentum and could fall here.
THE BOTTOM LINE:
The S&P 500 is right at its old high it hit last September. Traders are looking at this area very carefully as to whether it will break out of the 2954 number and follow through on the upside. I am Cautious on the market unless the S&P 500 rallies above the 2954 level on the S&P 500 and stays above that level for a least 2 to 3 days. If the S&P 500 closes below 2886 I would reduce some equity exposure as it would have broken a significant trend line and could push the S&P in a downtrend again. As for interest rates, they are back down to 2.55% on the ten-year bond. The tariff situation if not resolved would give investors a chance to sell and push the market lower. Other than that outside of ongoing political issues, the economy is doing relatively well, and a recession is not on the horizon, at least not over the next year. If you are a longer-term investor, stay the course, if you are in or nearing retirement, you may want to sell 10% of your holdings and rebalance your portfolio.
*A Support or support level is the level at which buyers tend to purchase or into a stock or index. It refers to the stock share price that a company or index should hold and start to rise. When a price of the stock falls towards its support level, the support level holds and is confirmed, or the stock continues to decline, and the support level must change.
Source: Investopedia
Support levels on the S&P 500 area are 2910, 2850, 2800, 2766, 2676 and 2600 areas. These might be BUY areas.
Support levels on the NASDAQ are 7979, 7801, 7572, and 7410.
On the Dow Jones support is at 26,240, 25856, 25,471 and 25,120. These may be safer areas to get into the equity markets on support levels slowly.
RESISTANCE LEVEL ON THE S&P 500 IS 2740. If there is a favorable tariff settlement, the market should rise short term.
Best to all of you,
Joe
Joe Bartosiewicz, CFP®
Investment Advisor Representative
Contact information:
Joe Bartosiewicz, FP®5,
Colby Way Avon,
CT 06001
SECURITIES AND ADVISORY SERVICES OFFERED THROUGH SAGE POINT FINANCIAL INC., MEMBER FINRA/SIPC, AND SEC-REGISTERED INVESTMENT ADVISOR.
Charts provided by AIQ Systems:
Technical Analysis is based on a study of historical price movements and past trend patterns. There is no assurance that these market changes or trends can or will be duplicated shortly. It logically follows that historical precedent does not guarantee future results. Conclusions expressed in the Technical Analysis section are personal opinions: and may not be construed as recommendations to buy or sell anything.
Disclaimer: The views expressed are not necessarily the view of Sage Point Financial, Inc. and should not be interpreted directly or indirectly as an offer to buy or sell any securities mentioned herein. Securities and Advisory services offered through Sage Point Financial Inc., Member FINRA/SIPC, an SEC- registered investment advisor.
Past performance cannot guarantee future results. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Please note that individual situations can vary. Therefore, the information presented in this letter should only be relied upon when coordinated with individual professional advice. *There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss in periods of declining values.
It is our goal to help investors by identifying changing market conditions. However, investors should be aware that no investment advisor can accurately predict all of the changes that may occur in the market.
The price of commodities is subject to substantial price fluctuations of short periods and may be affected by unpredictable international monetary and political policies. The market for commodities is widely unregulated and concentrated investing may lead to Sector investing may involve a greater degree of risk than investments with broader diversification.
Indexes cannot be invested indirectly, are unmanaged and do not incur management fees, costs, and expenses.
Dow Jones Industrial Average: A weighted price average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ.
S&P 500: The S&P 500 is an unmanaged indexed comprised of 500 widely held securities considered to be representative of the stock market in general.
NASDAQ: the NASDAQ Composite Index is an unmanaged, market-weighted index of all over the counter common stocks traded on the National Association of Securities Dealers Automated Quotation System
(IWM) I Shares Russell 2000 ETF: Which tracks the Russell 2000 index: which measures the performance of the small capitalization sector of the U.S. equity market.
A Moderate Mutual Fund risk mutual has approximately 50-70% of its portfolio in different equities, from growth, income stocks, international and emerging markets stocks to 30-50% of its portfolio indifferent categories of bonds and cash. It seeks capital appreciation with a low to moderate level of current income.
The Merrill Lynch High Yield Master Index: A broad-based measure of the performance of non-investment grade US Bonds
MSCI EAFE: the MSCI EAFE Index (Morgan Stanley Capital International Europe, Australia, and Far East Index) is a widely recognized benchmark of non-US markets. It is an unmanaged index composed of a sample of companies’ representative of the market structure of 20 European and Pacific Basin countries and includes reinvestment of all dividends.
Investment grade bond index: The S&P 500 Investment-grade corporate bond index, a sub-index of the S&P 500 Bond Index, seeks to measure the performance of the US corporate debt issued by constituents in the S&P 500 with an investment grade rating. The S&P 500 Bond index is designed to be a corporate-bond counterpart to the S&P 500, which is widely regarded as the best single gauge of large cap US equities.
Floating Rate Bond Index is a rule-based, market-value weighted index engineered to measure the performance and characteristics of floating rate coupon U.S. Treasuries which have a maturity greater than 12 months.
Short Term Corporate Bond ETFs seek to track the shorter maturity side of the corporate bond market. These are debt securities issued by companies and can include investment-grade debt, lower-quality junk or high-yield bonds. Short-term bonds are generally defined as those with maturities of less than five years coupon U.S. Treasuries which have a maturity greater than 12 months.
The 10–year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10–year Treasury note pays interest at a fixed rate once every six months, and pays the face value to the holder at maturity.
AI issued a market down signal of 99 on April 18, 2019. price Phase, our custom indicator that we use to confirm ratings turned down 4 days after the rating. Usually we like to see this indicator turn down closer to the rating, but the AI Expert system is often a little early.
The two significant rules rules that fired on this 99 down are below
“Intraday high prices of the market have increased to a 21 day high. Never the less, the advance/decline oscillator is negative. This unusual event is read as a very strong bearish signal that is often followed by an downward price movement. “
“Intraday high prices of the market have increased to a 21 day high. But the up/down volume oscillator if negative. In this uptrending market, this is taken as a very strong bearish signal that is often followed by downward price movements. “
The prior AI rating on the market was a 100 up on March 11, 2019 the market moved up over 850 points to the April down signal. Here are the AI rules that fired for this rating
“The market closing average has exceeded the 21 day exponentially smoothed average price. At the same time, accumulation is increasing in a strong down market. This is taken as a bullish signal that could be followed by a reverse in trend direction. “
“The Money Flow Indicator has reversed and is now advancing. In this downtrending market, this is taken as a weak bullish signal that could indicate an upward movement in the market averages. “
“Analysis of the rate of change of the exponentially smoothed average price suggests that in this strongly downtrending market an uptrend is starting to form. This is taken as a strong bullish signal that is usually followed by an upward movement in prices. “
“The new high/new low indicator has reversed to the upside. This is a reliable bullish signal that is often followed by an upward movement in prices. In this strong downtrending market a reverse in trend could start shortly. “
Ultimately any AI down signal is a note of caution in this market.
