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:
| Action | Date | TLT 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.
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?
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.
It looks like a decent rule, though I would want to check how it fared from 1950-1981 or so. Yes, there is still 30 bps of room at present on that indicator.
And, I haven’t sold yet — I want to watch the market for a little while longer.
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.
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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.
Thanks David. I look forward to hearing your evolving thoughts on the matter. This is a huge question (perhaps the biggest of all).