Last week was a difficult week for those of us that own bonds. In particular, ETFs like the iShares 20+ Year Treasury Bond Fund (NYSE:TLT) and the Vanguard Extended Duration ETF (NYSE:EDV) were hit the hardest as bond yields jumped (which resulted in the value of our bonds going down). The recent statement by the Federal Reserve is partly responsible because the statement introduced uncertainty and confusion as to the direction of interest rates.
According to one research firm, last week saw the biggest week-over-week percentage gain in global bond yields ever. For instance, the Netherland’s 10yr bond had a 73% move in yield, while the 10 year German Bund had a whopping 157% move in a single week!
On a relative basis, a 10% move in the 10-year U.S. Treasury Note (CBOE:TNX) was unpleasant, but in no way catastrophic. It is highly unusual for bonds to move in lock-step across so many countries at the same time – especially when those moves weren’t correlated to something like a similar move in the US Dollar.
Money managers are tasked with the responsibility of trying to protect and grow their client’s money through all market cycles. Most of us have processes and strategies that we use to help us do that. In other words, few successful managers make decisions based on hunches or the seat-of-their pants. Instead, they try to identify trends and cycles. They may apply statistical analysis to determine probabilities and ranges. Most successful managers find the process that works for them and they stick with it.
There will be times, though, when even the best strategies and processes can produce disappointing results. That’s because there isn’t any single process that will be 100% successful all the time in every type of market. So the key to the long-term success of any money manager is what they do when something unexpected happens.
I use a variety of different strategies and processes because I realize that each has its strengths and weaknesses. For bond ETFS like TLT and EDV, I am using a strategy that relies heavily on global macro analysis. It applies statistical analysis on a country by country basis to determine the rate of change in growth, inflation and policy. From there, probabilities are used to develop a trading range for specific metrics like 10-year US Treasury yields.
We all strive to buy low and sell high, but how can we know when low is low enough or high is high enough? The trading ranges supplied by that process seeks to quantify the low and the high mathematically.
That brings me to why I haven’t sold the TLT position even after it had a big down week last week. It would have been ideal to have sold those positions a week ago before yields started to rise because it would have then allowed me to move that money back into those positions at a lower price today. I didn’t do that because the yield of 1.92% was in the middle of that day’s trading range. Statistically it is best to hold in those situations. In other words, I didn’t sell last Friday because of ‘process’ in the same way that I am not selling now because of ‘process’.
That brings me to where we are today. Individual investors are often criticized for buying and selling at the wrong time. Professional money managers are just as prone to react emotionally as the individual investors they often criticize. That’s why I rely on tools like these probabilities because they help me act rationally in the midst of a high level of emotional stress.
The last few days, TLT has been at the top if its range. Statistically, that is the most opportune time to buy bonds and bond ETFs like TLT, so to sell that position now would be to do the exact opposite of what is needed. On the other hand, the probabilities regarding equities last Friday showed that it was time to lock in profits so that is what I did. When the stock market corrects back down to the lower end of its probability range I will likely move more money back into equities. Likewise, when the 10 year US Treasury yields move back down to the lower end of their range I will likely move to reduce the size of our positions in TLT and EDV.
The next big data point that has the potential to impact interest rates (and bonds) is the jobs report on May 8th. It is likely that the US Treasury market will remain volatile between now and then so I will continue to watch this closely.
The markets don’t always do what we expect. That’s why we have to rely on processes and systems developed and refined over the years.
Jeff’s Trending Indicators
US Stock Market Trending Up
US Bond Yields Yields Trending Up (means prices go down)
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The author holds positions in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.