Considering Selling the Long End

This will not be a long post.  My bond strategy has always included longer bonds from LQD, and very long bonds from TLT.  They have made money for me & my bond clients.  But now I am thinking of selling them.  Why?

Let’s consider the history of QE:

ActionDateTLT Return
QE4

12/12/2012

-1.16%

QE3

9/13/2012

-0.39%

Operation Twist

9/21/2011

3.31%

QE2

11/3/2010

-2.04%

QE1

11/25/2008

2.94%

Now, QE2 was kind of wimpy, and disappointed the markets.  All the other actions qualified as bold, but bold actions are not moving the needle at present.  Why?

I suspect that bond investors are embedding higher inflation forecasts into their prices, and that the balance has tipped. Inflation is coming, and I am likely to trade away longer nominal bonds for short bonds, and inflation-adjusted bonds.

The market is responding differently to loose monetary policy than it used to respond.  Time to adjust; the illusions of the Fed are finally failing, I think, and markets may be about to discipline them with stagflation.

Full disclosure: long TLT & LQD, but might be moving for cover.

9 Comments

  • Greg says:

    David – I can’t remember where I read this first, but there is a “bond indicator” that compares the Moody’s Baa index yield with its 200 day moving average… and that has worked quite well historically for allocating in and out of corporates.

    Did I read about that indicator on your blog (in the past)? Is that indicator flashing red now?

  • Greg says:

    Follow up … think I may have seen this bond indicator on Tom Brakke’s blog:
    http://researchpuzzle.com/blog/2010/09/15/the-indicator-revisited/

    The indicator seems to be signaling all clear for now (I pulled data from St Louis FRED database) — but I tend to agree with the concerns in your post.

    We will all pay a terrible price for what Bernanke is doing.

  • cold.as.ice says:

    sell TLT and buy short.

    Any thought about something like in place of buy short?

    – Inverse ETF such as TBF

    – Buy the put or sell the call vertical spread.

    • I’m a low-complexity guy with bond strategies & ETFs. Also, if I use levered, inverse ETFs, or use options, I would have to get new E&O insurance — quite expensive.

      I stick with what I know, and try not to over-optimize.

  • richt says:

    Wow, that is a very interesting call, because it seems to me that up until recently you were thinking that it could be a long time before rates and inflation went up. (We even had a little Twitter exchange about it a couple weeks back).

    Am I misinterpreting your views, or is this a pretty fundamental shift in your outlook?

    Thanks!

    • The operative word is “consider.” I haven’t sold it yet. What I am seeing is that the market may be operating on a different basis now, but I am waiting to see confirmation of that.

      Though I thought low rates could remain for a long time, that did not preclude my looking for a change in behavior — I asked both leading deflationists (Schiller & Hoisington) what would lead them to change their views. Both said a rise in bank lending leading to inflation.

      We may be at that cusp now; thus, I am watching closely.

      • richt says:

        Thanks David. I look forward to hearing your evolving thoughts on the matter. This is a huge question (perhaps the biggest of all).

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