Bonds now the market’s whipping boy

Quick, now: can you name the new whipping boy in the investment world? If you said bonds, you’d be right. After last year’s “taper tantrum” — i.e., the sell-off in the bond market — bonds have been shunted aside in favor of equities and other risk assets.

But there’s been an interesting development with long bonds — a development that may be of interest to technical traders.

Simply put, the charts now suggest that with both U.S. and Canadian long bonds — those of 20 years or more — investors may be able to take advantage of upside potential over the near term.

Take a look at iShares Trust Barclay 20+ Year Treasury Bond (TLT-NYSE, $111.10), a bond etf / exchange-traded fund that tracks the U.S. government 20-year bond, the movement of which I’ve outlined in a chart below.

Click below to enlarge

US Treasury

I’ve drawn a neckline on what appears to be a “phase one bottom formation,” which actually looks like a double bottom formation.

Moreover, as potential targets, I’ve also marked first and second levels of technical resistance.

I believe the U.S. long bond will experience upside during the seasonally strong period for bonds over the summer — perhaps to target one of these two resistance points.

Now, look at another bond ETF chart below here, this one for iShares Canadian Long Term Bond Index (XLB-TSX, $22). 

Click below to enlarge

Scotia CDN long term

The chart shows a pattern similar to that of the Barclay 20+ year fund, possibly displaying a head and shoulders phase one bottom formation.

Target looming closer

Not only has the first resistance level been taken out by this ETF, but my price target of roughly $22.50 a unit looks quite close.

Compared to the U.S. long bond, the comparative upside potential for the Canadian market may be a little less significant.

Still, both bonds are attractive for what appears to be good upside potential over the near term.

But if you’re still reluctant to buy bonds and go against the grain, take heart.

Although buying when others are selling and selling when others are buying does take the greatest fortitude, it also pays the greatest rewards, as the late great Sir John Templeton once noted.

So, it may now be a reasonable time to hold some longer duration bonds in your portfolio for a three-to-six month trade.

If you want another short to mid-term play this summer, consider capitalizing on the market’s recent move out of higher risk equities into lower risk sectors, such as consumer staples and utilities.

To play U.S. consumer staples, consider SPDR’s Consumer Staples Select Sector ETF (XLP-NYSE, $43.21); to play the Canadian sector, try iShares S&P/TSX Capped Consumers Staples ETF (XST-TSX, $33).

For U.S. utilities, meanwhile, you could buy SPDR’s Utilities Select Sector ETF (XLU-NYSE, $43.21), while for Canadian utilities, you could consider BMO’s Equal Weight Canadian Utilities ETF (ZUT-TSX, $15.79).

Sectors from which investors are now fleeing include biotech, small-cap stocks, as well as the broader NASDAQ composite.

Not surprisingly, these “risk on” sectors are largely falling in sync with the rapid rise in the defensive sectors.

You might want to reduce your exposure to some of the higher beta names in your portfolio that fall within those categories.

For my part, I believe this rotation out of riskier sectors may be a telling sign of a pending correction in the broader market.

Remember that back in January and, again, in early April, major stock markets around the world were shaken by a new pattern of volatility.

That both of these sell-offs were followed by rallies suggests the low level of volatility that has been felt since 2012 may be coming to an end.

In fact, I believe that market volatility, or choppiness, will be with us for a while.

Indeed, as we enter the seasonally unfavorable period for stocks over the summer — a period that usually lasts six months — the market is likely to be hit with more volatility, even though there was no volatility over the previous summers.

Admittedly, over the last few years, we’ve had summer rallies, although they were largely fueled by the actions of the U.S. Federal Reserve, as well as by the big flow of money out of bonds into stocks.

Tendency persisted

Moreover, even during the recent string of strong summers, there was a tendency for some type of sell-off.

For example, during the summers of 2010, 2011 and 2012, markets peaked only to decline to some degree.

The main difference between those years and “traditional” ones was the tendency for the bottom, or trough, to form earlier than usual.

Typically, markets show their worst performance leading into low points in September or October.

But 2010’s trough low formed in late June, that of 2011 in September, while he trough low of 2012 occurred in late May.

Given that there’s almost no chance of monetary stimulus this summer, it’s unlikely the broad market will perform as well as it has in recent years.

Of course, there will probably be short-term rallies. But when all is said and done, investors would do well to have a portfolio that has low risk and that focuses on sectors such as consumer staples, bonds and utilities.

Moreover, it’s hard to predict if we’ll have a summer sell-off in 2014 and, if so, when.

But guessing the timing of a market peak and trough is likely less significant than being aware of the increased potential for such an occurrence to occur this year.

Rightly or wrongly, I’ve taken a defensive posture with the equity funds I oversee here at Value Trend, using some of the ideas I’ve outlined above.


Keith Richards, based in Barrie, Ont., is portfolio manager of Value Trend/Wealth Management.


Investor’s Digest of Canada, MPL Communications Inc.
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