Treasury yields fell Monday and bond ETFs rallied as fears Greece will leave the euro continued to rattle global markets. Most European indices were down more than 2% while yields on the 10-year Treasury note traded under 1.8% with investors preferring the safety of U.S. government debt.
A frequently highlighted trade over the past several years has been that of the “Bond Bears” which is predicated on shorting longer dated U.S. Treasury Bonds (betting on lower prices and thus higher yields) via shorting iShares 20+ Year Treasury Bond (TLT - News) and/or buying TLT puts and/or establishing long positions in leveraged/inverse products and options including ProShares UltraShort 20+ Year Treasury Bond (TBT - News) and Direxion Daily 20+ Year Treasury Bear 3X (TMV - News).
TLT was up more than 1% in premarket while Dow futures slipped about 100 points before the bell.
Towards the end of last week, with longer dated U.S. Treasury bonds challenging new multi-month price breakout levels (and thus hovering at relatively low yields again when say compared to where these markets were just a little more than a month ago in March) we saw bearish looking activity in TLT via puts and the accumulation of TBT calls, but we caution those looking to piggyback to look at the track record of this trade. With the exception of a a few “hiccups” here and there, including a steep but short lasting sell-off in bond prices in March of this year, longer dated U.S. Treasury Bonds continue to remain in a multi-year uptrend, with buying pressure exacerbating in periods of Euro fueled tensions (such as last summer’s fallout and market action in the past week or two of this year) as the “flight to safety” trade continues to swing towards U.S. Treasuries in times of distress.
Short of “picking spots” and being adept enough to trade on temporary price corrections in long term Treasuries before covering, those who have established longer term bearish positions (as evidenced by the mounting short interest throughout the spectrum of Treasury related derivatives including futures, options, swaps, and ETFs) have clearly felt the pain of being “wrong” as a bear more often than being “right” in this multi-year bull market in U.S. Treasury Bonds that seemingly refuses to crack.
Equity indices degraded further last week with the SPX (S&P 500 Index) now trading below its 50 day moving average for the past six trading sessions and closing at 1353.39. Trading volumes in the overall marketplace also picked up substantially and our market technician David Chojnacki pointed out late last week in a note to trading clients that “Technicals remain weak, with RSI’s near 40 or just below, and ROC (10’s) negative” and “Below the 1358 level in the SPX we may test the 1340 level again.” The Euro was pressured throughout the week, with FXE (CurrencyShares Euro) trading at its lowest levels versus the U.S. Dollar since mid January, reflective of the daily headline tensions that have surfaced in recent weeks surrounding the ongoing European debt crisis that is plainly said, very far from resolution apparently.
Options markets activity has been cautious for weeks as we have pointed out on frequent occasions consisting of broad based hedging activity via puts in products including SPY, IWM, and EEM for instance. The fund flows that we highlighted in last week’s weekly recap clearly demonstrated that institutions were leaning towards caution, with significant inflows occurring in conservative short and medium duration fixed income ETFs and outflows in higher beta segments of the market such as technology (QQQ) and small caps (IWM).
This past week, we saw additional evidence that institutions are concerned about potentially going into the summer overexposed to equities as the leaders in fund outflows were SPY ($-2.3 billion via redemption activity) and EEM (iShares MSCI Emerging Markets) which lost $1.2 billion last week. A related ETF, VWO (Vanguard Emerging Markets) also lost approximately $200 million. We have wondered out loud for several weeks when the seemingly resilient Emerging Markets ETF space, which reeled in more than $8 billion collectively in new assets via creation activity in the first months of the year, would finally crack and this week the selling pressure was evident.
When the equity market looked like it was in unabated bull rally mode back in January of February of this year, conceptually it made sense that Emerging Markets funds such as EEM and VWO would attract significant asset flows given the relative under-performance to U.S. equities in the trailing one year period, and the higher beta nature of these markets. In the trailing one year period, EEM for instance has lost 17.17% versus the S&P 500 up 1.01% during this same time frame. China is the single largest country weighting in EEM, at nearly 18%, and the country’s equity market has notably under-performed other segments of the market, with FXI (iShares China) for instance losing 19.30% in the trailing one year period. After weeks of witnessing protective activity in EEM via put spreads and outright put buying, it was not completely surprising to see some institutions fold their hands at least for now in emerging markets equities, and allocate to other asset classes.
In bonds, a very large trade occurred in SPDR High Yield Bond (JNK - News) mid week last week as well, with about $800 million leaving the fund on a single 19 million share block print. [High-Yield Bond ETF Sees Volume Spike]
Given the recent downturn in equities and namely the higher beta segments such as Small Caps, the High Yield Bond market has been surprisingly resilient with JNK and related ETF HYG (iShares High Yield Corporate Bond) actually flirting with multi-year highs. Nonetheless, clearly an institution wanted to cash out of their high yield bond exposure last week in a rather aggressive manner. A handful of equity sector ETFs also spilled out assets last week, namely XLE (SPDR Energy), XLI (SPDR Industrials), and XLF (SPDR Financials, which JPM is the second heaviest weighting in, and clearly that name was all over the news late last week amid news of a $2 billion trading loss for the firm). Collectively, approximately $1 billion flowed out of the funds in total.
In absolute terms, net inflows last week were very small in comparison to outflows, as IWM was the leader across the ETF space, taking in only approximately $300 million during the week (compared to several funds including SPY and EEM for instance losing more than $1 and $2 billion last week via redemptions). Also, in a continuation of flows from two weeks ago, several fixed income names continued to attract new assets amid the recent environment of institutional caution, as SHY (iShares 1-3 Year Treasury Bond)l IEF (iShares 7-10 Year Treasury Bond), and BND (Vanguard Total Bond Market) for instance reeled in close to $400 million collectively.
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- Treasury Bonds