Tuesday, April 28, 2009

Long Treasury Bond Nearly Back to 4%

Top Line: The stock market should be nearly ready for a strong run up.

[Editor's note: There will be no Thursday evening post this week. We will post on Wednesday evening but not again until Sunday evening.]

The media would have us believe that the swine flu and some bad news on the banks is the cause of the weak performance the last few days. We say, "What weak performance?" The Dow is down just about 60 points in the last two days and the news is being pumped up to fit a 600 point drop.

Consumer confidence jumped in April to 39.2 compared to a revised 26.9 last month. The expectation was for the number to rise to only 29.5. The world isn't sure what to make of some of the "positive" reports. We expect them and so does the market.

Normally, we are talking about the jobs' report since May 1st is Friday, but not this month. The jobs' report is coming out next week Friday, the 8th of May.

One subtle shift in the past few days is being almost totally ignored by the media and that is the break down in the Treasury bond market. Today the long bond nearly pushed above 4%. If you recall, that rate was about 2.5% at the end of December. The reason the media is ignoring it is because they don't understand or realize the significance of the news.

We have discussed the bubble in the bond market that occurred back in December. The consequences of a bubble are normally a severe correction or worse. With the Treasury bonds, we did see a large drop in prices during January but since then prices have stabilized until the past few days. This break seems to open the door for higher interest rates shortly.

As you know, we follow TLT, an ETF of long dated Treasury bonds. TLT has been bouncing off the 100 line since February but today it broke through it and closed below it. When it hit 100 this afternoon, there were several sell stops that must have been sitting there because it dropped from 100 to 99.5 in about ten minutes. TLT traded above 123 in late December. So, even the Treasury bonds are risky, you can lose 20% in about a quarter with more losses to come.

The significance of this event is that as money is coming out of "risk free" assets, it probably will be going into "risky-er" assets like stocks. At the very least, Treasury bonds are falling in value. There seems to be an enormous amount of cash on the sidelines with everyone selling in the past six months and now they are selling the Treasuries as well. That cash needs to find a better home than money market funds. Stocks would be the logical choice.

(What's a sell stop? If you buy a stock or other asset, you can ask your broker to sell it if the price drops to a certain level. This is known as a sell stop, because you are selling your position and stopping the losses. Sell stops come in two forms, market sell stops and limit sell stops. When your stock goes down to your pain point it will either trigger a market order or it will put a limit sell order out there. Sometimes a limit sell stop never actually gets you off the position because the selling is so harsh that it "blows by you" on its way to much lower levels. Either way, we think sell stops are a good way to lose money because you automatically sell for a loss on the way down. We like to sell into Strength not weakness.)

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