Bond Bulls in the Driver's Seat

With the uncertainty around equity markets due to the recent correction, there seems to be a new round of piqued interest in the fixed income space, and thus interest rates as well. Are US Treasuries, typically viewed as a "safe haven" for investors in times of uncertainty, poised to see more gains? Should we be looking to put money to work in short- or long-dated areas? What does this mean for various equity sectors? We will take a look at all these questions and what the current landscape is telling us.

John Kolovos. Head of Technical Strategy at Macro Risk Advisors, appeared on Bloomberg earlier today. He pointed out the Death Cross that appeared on 10-year yield back in January and believes that there could be sustained downside. Thus, he says, bonds should continue in their respective longer-term uptrends:

Tarek Saab of Fibonacci.com points to the potential breakout in a popular risk-on/risk-off relationship, noting that 20+ Year Treasuries are moving higher against High Yield Corporate bonds:

Fellow TCR contributor Steve Strazza has given us a wonderful view of Treasuries across a couple of different maturity time frames, including 3-7 years ($IEI) and 20+ years ($TLT), both of which are moving above their highs from late March. He also mentions that the broad bond market ($BND), tied to the Barclays US Aggregate Index, is moving to new highs:

In regards to longer-term Treasuries, David Larew points to the fact that 20+ Year Treasuries ($TLT) also seem strong:

As foreign investors (outside of China) pile into US Treasuries at the highest pace over the last year, this could also keep interest rates subdued for a period of time:

Longer-dated Treasuries have been outperforming during the most recent correction in rates as well, which makes sense in this environment. Shorter-term bonds will provide better total returns than longer-term bonds when yields are rising, while longer-term bonds will provide better total returns than their shorter-term counterparts when yields are falling. This also points the fact that fixed income investors are willing to take more risk:

What about other areas on the fixed income spectrum? Rates on Municipal High Yield bonds are also making new lows:

Callum Thomas of Topdown Charts brings to our attention that bond volatility could also be on the verge of making a big move, noting that "Bond market volatility is starting to pickup, and this comes after the MOVE bond volatility index made an all time record low in March this year.  It’s a bit of a cliché, but a fair rule of thumb is that low volatility is a good predictor of future higher volatility.  With bond yields on the precipice this is something to keep in mind!"

So, what does this mean for equity markets? Considering that many portfolio managers have maximum cash limits, this means that they have to stay long and many will look to put assets to work in Sectors/industries that see the largest benefits from lower interest rates. These include Utilities and Real Estate, which have been the top two performing Sectors in the S&P 500 over the last few weeks:

Mary Ellen McGonagle also mentions these two Sectors when looking for a safe place to put money to work, noting that "Income investors, as well as those looking to buffer their portfolios from any sharp gyrations in the U.S. Equity markets, may want to consider these four technically sound stocks, which can act as a buffer against continued volatility while providing growth prospects that should keep them attractive in the long run."

What about Preferreds, which have characteristics of both fixed income and equities? Just like bonds, which also make fixed payments, the market value of preferred shares is sensitive to changes in interest rates. If interest rates rise, the value of the preferred shares falls. The main reason to treat preferred stock as debt rather than equity is that it acts more like a bond than a stock, and investors buy it for current income, not capital appreciation. Like common stock, preferred stock represents an equity stake in a company, but its many features make it more like a debt security. So far in 2019, ETFs tied to Preferreds have seen some of the best returns:

From a contrarian perspective, and something to keep in mind as the talk about lower rates picks up, Tiho Brkan notes that according to the latest COT report, bullish sentiment among short-term Treasury bonds may be overdone:

With a breakdown in yields across various maturities in Treasuries, as well as the drop in rates we have seen in the Municipal bond space, most investors believe rates will continue to move lower. This sentiment also seems solid based on the increased buying of more rate-sensitive equity Sectors, such as Utilities and Real Estate. Volatility in bonds could also be ready for a spike. Given all of this information, it would seem that the weight of the evidence points to lower yields and higher bond prices for the foreseeable future. However, be careful of the latest pick-up in long positioning, as this has tended to lead to short-term peaks in the past.

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