Treasury ETFs: The Ultimate Contrarian Trade

ETF Trends

Treasury yields dropped sharply on Friday after a weaker-than-expected report on July new-home sales, pushing long-term bond ETFs into positive territory for the week.

Treasury ETFs are rebounding after a violent sell-off that has pushed bullish sentiment on bonds to the lowest level in over two years.

As a result, U.S. government bond ETFs are set up for a potentially powerful countertrend rally if Treasury yields take a breather after their recent spike.

“The yield on the 10-year Treasury note has shot from 1.63% in early May to a two-year high above 2.90% this week, scaring tens of billions of investor dollars out of bond funds and raising the price of credit across the economy,” writes Michael Santoli for Yahoo Finance.

Treasury yields jumped Wednesday after the release of the minutes from the Federal Reserve’s July meeting. The consensus is that the Fed will begin tapering its bond purchases sometime before the end of 2013. However, yields on the 10-year note fell as low as 2.81% on Friday after the new-home sales data.

“[A] few signs are coalescing to suggest the bond-selling, rate-boosting scare might be tiring. This would allow rates to ease back a bit, which in turn could fuel a nice relief rally in all manner of yield-centric investments that have been ravaged in the bond-market rout, from municipal bonds to real estate investment trusts to junk bonds and perhaps even homebuilder stocks,” Santoli wrote, adding that excessive pessimism has already built up in the Treasury market.

“This isn’t to say Treasury yields will nearly undo their entire surge this year or that they won’t eventually climb above 3% in response to expectations of a less-generous Fed or a pickup in economic growth,” he notes. “But for now, the yield advance has arguably overshot, and the sectors pummeled as a result have suffered from investors planning for a rapid and relentless climb in rates that isn’t likely to happen.”

A pullback in 10-year Treasury yields here also makes sense from a technical perspective. Chris Kimble at Kimble Charting Solutions points out that the rally has lifted the 10-year yield to the top of its long-term channel resistance, while momentum is the most overbought in seven years.

Meanwhile, only 23% of investors are bullish on bonds right now, the lowest level since early 2011, Kimble added, citing data from SentimenTrader.com.

If Treasury yields do correct, “then opportunistic investors might look to exploit it through roughed-up fixed income ETFs, such as iShares Barclays 20+ Year Treasury Bond (TLT), iShares S&P National AMT-Free Muni Bond (MUB), SPDR Barclays High Yield Bond (JNK) or the Vanguard REIT Index (VNQ),” according to Santoli. “With the 30-year mega-bull market in bonds likely having peaked, these are not buy-them-and-forget-them investments. But they could very well work for a trade, assuming the rate-rise panic subsides for a while.”

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Chart source: Kimble Charting Solutions, click image for larger version.

Full disclosure: Tom Lydon’s clients own TLT.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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