Historically, when the US stock market has been under prolonged duress, the one asset class that has served as a flight to safety in the markets has been the US Treasury bond. During these periods the Treasury bond often demonstrates an inverse correlation to stocks, with the potential to generate positive returns when stocks are down. However, when the stock market climbs, since the last bear market in bonds ended in the early 1980’s, often Treasury prices have increased as well. Of course, this has largely been driven by a multi-decade decline in interest rates and going forward rates have no where to go but up. Therefore, we anticipate this dynamic to change. What we don’t expect to change is the relative capital preservation characteristics presented by Treasuries when the equity markets decline.
In order for this long standing relationship to be able to continue, we have needed to see Treasury prices decouple from equities. From January 1st, 2014 to January 30th, 2015 (when Treasury prices reached their highs for the year) the SPDR S&P 500 ETF Trust (NYSE ARCA:SPY) was up 9.32%, at the same time the iShares Barclays 20+ Yr Treas.Bond ETF (NYSE ARCA:TLT) generated a wildly impressive 13 month total return of 33.76%. Surely, this could not continue, particularly as we move increasingly closer to a rate hike.
Anytime TLT has gone on an extremely pronounced run, upwards of 30% in recent years in a relatively short period of time, it has been followed by a correction of sorts.
- In 2008, when SPY lost -37%, TLT was up nearly 34%.
- In 2009, when SPY rebounded up 26.4%, TLT lost -21.5%.
- In 2011, when SPY was only up 2.1%, TLT rocketed up 33.6%.
- In 2012, while SPY generated strong returns of nearly 16%, TLT began to peter out up 3.2%.
- In 2013, when SPY put in the best calendar year return we have seen since the late 1990’s, up 32%, TLT decoupled down -13.9%.
- Last year, in 2014, TLT soared up more than 27%, while at the same time SPY posted a respectable return of 13.5%.
- Year to date through market close on May 13th, TLT is now down -4.82%, while SPY is up 2.64%.
For those more statistically inclined…
Since the highs reached earlier this year on January 30th through market close on May 13th TLT has dropped -13%, while SPY has been up 4.45%. We view this as a very good thing. We don’t want Treasuries to act like stocks when stocks are going up. The rapid pull back we have seen in recent weeks was absolutely necessary, particularly for those employing asset rotation strategies that depend on inverse correlations during times of peril in the equity markets. A “reset” had been becoming increasingly overdue.
In the near term however, it appears the rapid decent in Treasury prices may be oversold. The Wilder’s RSI number is at 19 and the Money Flow Index is at 18. With respect to both metrics, readings below 20 indicate oversold conditions indicative of short term bullishness. So from current prices we may likely see some sort of bounce, but the more intermediate and long term conditions may very well have some room to run on the downside. Consider with as much as TLT was up last year, at current prices we have only fallen to where TLT was trading in November of 2014.
On a side note, we find it interesting that price action year to date suggests a rotation out of longer term Treasuries and into shorter maturities. TLT is down -4.82% year to date, but the iShares Barclays 7-10 Year Trasry Bnd Fd is positive 0.25%, while the iShares Barclays 3-7 Year Treasry Bnd Fd is up 1.08%. This compared to the Barclays US Aggregate Bond Total Return Index being up 0.25%. This only makes sense, as investors fearing an increase in interest rates look to reduce duration risk by selling longer dated maturities and buying shorter ones.
The following is a daily snapshot of some of the notable indices and benchmark ETFs we monitor: