3%+ Forward Yield on TLT -- Is It Time?

A lot has been made about yields in recent weeks. Many renown investors have publicly taken both sides of the treasury trade - long treasuries because an economic slowdown is imminent; short treasuries because yields appear to be breaking out and the long-term yield cycle may not top until 2040. Below we will break down both sides of the trade and offer our thoughts.

Let’s start with the ETFs that offer exposure to the Treasury curve. There are many, but the ones we look to most are SHY (1-3 Year Treasury), IEF (7-10 Year Treasury), and TLT (20+ Year Treasury). What is most important when evaluating these ETFs is to understand that an investor is not buying the actual treasuries, in other words there is principal risk. Going long/short one of these ETFs is a trade against what may happen in the yield curve (which we discussed initially here).

TNX is the ticker for the ten-year yield. Recall that price and yield have an inverse relationship. Here is what TNX looks like on the monthly and weekly charts right now. From a technical perspective, there is not much resistance on the TNX monthly chart. If yields do indeed breakout beyond 4.33, things could go haywire for interest rate sensitive businesses (commercial real estate, regional banks, very early stage growth companies).

Recent bond bears include renown investor Bill Ackman and renown technician Tom McClellan (who popularized the McClellan Oscillator). We covered Bill’s call recently on Twitter/X. Tom has called for yields to top in 2040 which would mean an interest rate regime that most investors today have not experienced.

We know that businesses characterized by strong present-day cashflows and properly capitalized balance sheets with non-floating rate debt perform best in this type of environment. This is exactly what we saw off the bottom in Fall 2022. The QQQ and XLK indices put in a near perfect “cup” pattern

Bond bulls are relying on a “mean reversion trade” or perhaps a double top in yields (corresponding to the potential double bottom in TLT, discussed below). However, while much has been made of the near perfect correlation between TLT and equities in 2022, the long-term correlation is actually much weaker.

Given the fact that the historical correlation between TLT and equity prices is weak (about -0.2), and the fact that in 2023 equity indices have performed well as yields have been rising, we do not believe that the price gap between TLT and QQQ “needs” to close in the near future.

That being said, real interest rates (fed funds rate - inflation) are firmly positive which (theoretically) has a dampening on economic activity, since saving is rewarded with interest in excess of inflation. If a slowing in economic activity starts to appear in the data (GDP lower than expected, jobless claims higher than expected, etc.) then TLT will likely experience a jump in price as the “flight to safety” trade picks up.

However, economic data has not slowed yet, and there is no point in guess when it may begin. Pundits looking for stagflation have been completely blown out of the water. Stagflation requires inflation with a stagnant economy, we simply do not have a stagnant economy right now. I am open to this fact changing, it is just not where we are at the moment.

If an investor wants to get involved in the TLT trade (I do not right now), the best strategy is to react to price on the TLT chart. If we wait for economic data to reflect a slowing economy, it is likely that TLT will already reflect this as markets are forward looking. Therefore, it is best to react to the price chart.

So, here is TLT. The weekly chart looks like absolute garbage, but the daily chart is showing signs of a potential double bottom - for the record I am not involved in the trade at the moment.

It has no doubt been a brutal 18 months for risk-parity investors and 60/40 portfolio investors. At some point, there will be a reversion trade, but there is no point trying to guess.

For a textbook double bottom, price undercuts the lefthand bottom briefly and then quickly/firmly retake that level. The initial bottom in the fall of 2022 was just below $92. This is about 4% risk as of 8/23 pre-market trading.

Remember that buying TLT is not the same as buying a 20 year Treasury. To play TLT is to play the yield curve gyrations and, effectively, speculate on future monetary policy.

EDIT: I am in the trade as of this morning, long $TLT with a stop of “acceptance below $90/share”.