From the Desk of Ian Culley @Ianculley
Bonds have endured quite the year.
Perhaps 2022 marks the worst on record, or at least the past 100 years. Nevertheless, we’ve all witnessed extraordinary selling pressure in what has historically acted as a safe-haven asset.
Despite the dismal returns and destruction of the traditional 60/40 portfolio, the bond market continues to instill valuable lessons in those willing to listen and learn.
Check out these three poignant reminders courtesy of the bond market…
Trends Persist
It’s an oldie but a goodie. And interest rates have refused to let us forget that trends persist.
The chart below highlights the five-, 10-, and 30-year US Treasury yields finding support at their respective year-to-date trendlines and pivot highs from the spring.
I thought rates might follow the dollar lower at this juncture. I mean, it’s been US dollar and rates all year, right?
Nope, that was not the case.
Especially not when rates continue to rise overseas.
Developed European yields have proven prescient when determining the future direction of US rates during the past year (that’s another trend that remains intact).
European yields point the way higher, as the benchmark rates of Germany, France, Spain, and Portugal print fresh multi-year highs.
So far, the relentless rally across the pond suggests higher rates stateside. As long as this relationship holds, we expect US yields to rise in the coming weeks.
It looks like more pain lies ahead for bond investors, and that brings us to lesson No. 2…
Not All Good Trades Are Profitable
This might sound crazy to the uninitiated, but I’d rather lose money on a good trade than make money on a poorly executed one.
Poor trades lead to bad habits and large losses – been there, done that.
On the flip side, taking a signal within your plan and managing risk are critical ingredients to any successful trading approach.
Yeah, so those bond trades from earlier in the month failed – all of them:
And it makes sense given the bounce in US rates and the multi-year highs in European yields. Those were key pieces of evidence that never confirmed the breakouts in US Treasuries.
Nevertheless, taking losses is never fun. But making money is our first priority, not having fun. Sure, fun comes in second, but it’s not even close.
I can live with a trade, regardless of P&L, if I can look back and justify my entry and exit.
It’s well-executed losses – such as the recent breakouts in bonds – that build character and longevity.
Thanks, bond market!
Correlations Come and Go
You’ve heard it a thousand times or more – correlations come and go. It’s just the way the world works, markets included.
The bond market provided an excellent example this fall as the positive correlation between long-duration assets decoupled.
Check out the overlay chart of the US T-Bond ETF $TLT and the Ark Innovation ETF $ARKK with a 63-day correlation study in the lower pane:
As bonds rallied in November, mega-cap growth stocks did not participate.
The sideways action in ARKK and the declining positive correlation highlight the breakdown in this classic relationship.
The question back then was, how will growth areas of the market fare when bonds begin to correct?
Well, we have our answer. The positive correlation has reasserted itself as increased selling pressure hits long-duration assets, in general.
I imagine this relationship remaining intact in the near term with the understanding it will eventually break down.
The fact trends persist, correlations come and go, and good trades lose money might seem obvious, juvenile even.
I look to the bond market as a guide and a teacher.
Instead of giving me the answers I want to hear (winning trades, lower rates, etc.), it drills enduring market principles tick by tick.
As long as you’re willing to listen and accept its instructions, the bond markets will continue to sow valuable lessons.
Have a safe and happy New Year!
Countdown to FOMC
Following the recent double-hike, the market is pricing in a single-hike at the February meeting.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
This data is from the CME FedWatch Tool as of December 29, 2022.
Thanks for reading. And please let us know what you think.
As always, be sure to download this week’s Bond Report!
