What If the Best Stock Isn’t a Stock at All?
While stocks turn volatile, this investment has a promising path higher.
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If you believe that interest rates are headed lower, as most of us do, then you also believe that bond prices will soon move higher. This is due to the inverse relationship between bond prices and their associated yields. When one rises, the other one falls.
This raises an interesting question — instead of worrying about which stocks to add to your portfolio, why not focus on which bonds to buy?
If you’re attempting to parse the next move for the stock markets, you are faced with the following question: Will falling interest rates prop up stocks, or will a faltering economy lead shares lower?
The near-term direction for high-quality bonds is less opaque. Interest rates are almost certainly headed lower, and that should place upward pressure on bonds.
First let’s look at the big picture, using the iShares 20+ Year Treasury Bond ETF TLT as our guide. This bellwether ETF’s holdings consist entirely of U.S. Treasuries.
On the long-term weekly chart, we can see that the TLT ETF has been crushed. TLT has lost about 45% of its value since the early days of 2020.
Over the past four years, TLT investors have lost money because they held U.S. Treasury bonds as interest rates were rising. The Fed funds rate has climbed from 0.05% in early 2020 to its current level of 5.33%. When interest rates rise, bond prices tend to fall.
However, if we zoom in to the daily chart, TLT is setting up for a rally. TLT has formed a rounded bottom pattern over the past six months (shaded yellow). This large bullish pattern suggests TLT could climb to $110, a level not seen in nearly two years.
In mid-July, TLT’s rising 50-day moving average (blue) crossed above its rising 200-day moving average (red), a bullish momentum indicator.
Note that the chart of low-quality, high-yield bonds doesn’t resemble TLT. The iShares High Yield Corporate Bond ETF HYG doesn’t appear to be on the verge of a breakout. HYG has been treading water for the past six months. I'm avoiding high-yield bonds.
According to the CME’s FedWatch Tool, the odds of a rate cut at the Fed’s September 18 meeting are 100%. The question is no longer “will the Fed cut interest rates.” Now, investors want to know how large of a cut the Fed will enact.
Currently, there is a 33.5% chance of a 25 basis point rate cut in September, and a 66.5% chance of a 50 basis point cut. By year’s end, odds now point to a total cut of 100 basis points.
In addition to TLT, there are other U.S. Treasury-based ETFs to consider. The ProShares Ultra 7-10 year Treasury ETF UST has a similar chart to TLT, including the bullish rounded bottom and moving average crossover.
In addition to high quality Treasuries, UST provides 2x leverage. Leverage is a double-edged sword, so be cautious when trading or investing in any leveraged instrument.
At the time of publication, Ponsi was long UST and TLT.
