BIG JUMP IN MATERIAL PRICES HURTS BONDS -- 30 -YEAR T-BOND YIELD IS BREAKING OUT -- BOND ETF FORMING DOUBLE TOP
MATERIAL PRICES HAVE BIG JUMP ... Long-term rates continue to rise in the face of rising inflation pressures. Over the last month, manufacturers reported the biggest jump in fifteen years in the prices they pay for materials. That means that upside pressures are building in the inflation pipeline. As you would expect, bond yields jumped sharply and bond prices fell as a result. Chart action shows that the recent rise in bond yields is starting to look more serious. Chart 1 shows the 10-Year T-note yield (TNX) climbing to a two-month high and nearing a test of its August high. As I've suggested recently, however, the more telling action may be in the long bond as shown in Chart 2. The 30-Year T-bond yield (TYX) has climbed over its 200-day moving average for the first time in more than a year. And it's on the verge of exceeding its August peak. The reason I think the more dangerous action is in the long bond is because the longest maturities have been the strongest part of the yield curve. In order to demonstrate that graphically, I'm going to switch over to bond prices.
Chart 1
Chart 2
COMPARISON OF BOND ETFS... Bond prices trend in the opposite direction of yields. Therefore, when bond yields are rising (as they are now), bond prices start to fall. Chart 3 compares two bond ETFs in different parts of the yield curve. The green line is the T-Bond 7-10 year iShares (IEF). It's a mirror image of the 10-year T-note yield (TNX) shown in Chart 1. The red line is the T-Bond 20-year iShares (TLT). It's a mirror image of the 30-year T-bond yield (TYX) in Chart 2. The point of chart 2 is to see their relative relationship. The shorter-term maturity (green line) peaked in the middle of 2003 and is now well below that level. The longer-term maturity (red line) has continued to rise into 2005. A comparison of the two maturities also shows that the 20-year bond (red line) has been much stronger than the 7-10 year bond (green line) since the start of 2005. If bond yields are really peaking, I think the main signal should come from the longer maturity. Let's take a closer look at the two bond ETFs.
Chart 3
A CLOSER LOOK AT BOND ETFS ... Chart 4 plots the T-bond 7-10 year IShares over the last 18 months. The chart trend has been erratic to say the least. Notice how many times, for example, the IEF crossed above and below its red 200-day average. There's also no clearcut trendline to measure the the erratic price advance. Since June, the IEF has formed a pattern of lower highs and is nearing a test of its August low. It's also trading back under its 200-day line for the fourth time in the last year. Notice how far the current price is above its major support line. That's not the case in Chart 5. The T-bond 20-year iShares show a much smoother uptrend since the middle of 2004. The TLT has just broken a rising trendline drawn under the June 2004/March 2005 lows which is a bearish signal. Prices are also bearing down on the red 200-day average which hasn't been broken in more than a year. A downside cross would be another bad sign. And, lastly, the chart has the definite look of a double top.
Chart 4
Chart 5
DOUBLE TOP IN BOND ETF ... One of the things I learned in charting a long time ago is to base my views on charts that are giving clearcut signals. In my view, the most clearcut chart pattern in the bond market is in the long bond as shown in Chart 6. The chart shows the late August rally in the T-Bond 20-year iShares failing at the twin peaks in June. Prices are now threatening the August low (and the 200-day moving average). I would take a decisive close below both of those support points as a significant bearish signal for the bond market. Another chart lesson I learned is to place more importance on signals where two support points are broken at the same time -- the August low and the 200-day average. The major up trendline shown in Chart 5 has already been broken.
Chart 6
WHAT DOES IT MEAN ... One thing a breakdown in the long bond would mean is that long term rates have finally bottomed. That's bearish for bonds. What it means for stocks isn't as clear. Rising interest rates are historically bad for stocks. Over the short-run, however, that's not always the case. Some money coming out of bonds would find its way into stocks which could provide some short-term support. But the ultimate message is bearish for both bonds and stocks. I believe that's what all the recent gold buying has been about as well as the recent weakness in homebuilders and REITs.
