It may sound crazy, but U.S. interest rates could be headed much lower…. even negative.
Some are now comparing the United States with Japan, where long-term bonds have been below 1% for years. That’s not surprising, low rates (below 2%) are normal in slow-growth economies burdened with high debt levels, according to research by leading economist. Slow growth and high debt sums up the state of today’s U.S. and Japanese economies.
Japan has suffered “a lost generation” since its stock market peaked in 1989.
Over the past twelve years, major stock market indexes have largely gone nowhere in the United States, prompting some to remark that investors have endured a “lost decade” of returns.
That does not mean traders need endure negative returns.
In fact, my 26-week “ROC” system is signaling to “buy” a security that should do very well if rates continue to fall.
The question traders face now is how low interest rates can go. Sweden, for example, has held some short-term rates below zero for a few years and other countries have followed. That means savers in those countries are essentially paying banks for the right to have money held in deposit accounts. The winners in these situations are traders who purchased bonds before rates turned negative, because they are enjoying capital gains as the value of their holdings increase due to falling rates.
When rates decline, bond prices rise. This is because bonds pay a fixed interest rate. If a bond is issued at 2%, it will always make interest payments that are equal to 2% of the issue price. As market rates change, the price of previously issued bonds must also change so that they will be competitively priced for investors. If rates decline, that 2% yield becomes more attractive and the price of those bonds will rise to reflect that. The price increase will continue until the older bond pays the same as the newer bonds issued at lower rates.
These market adjustments take only a few moments, but the trends towards lower or higher rates last for months and can clearly be seen in charts. If future rates are set to decline, then now is the time to buy bonds — and that is exactly what my 26-week rate of change (ROC) system is telling me to do.
This week, we’re adding iShares Barclays 20+ Year Treasury (NYSE: TLT). iShares JPMorgan Emerging Markets Bond (NYSE: EMB) will be “sold” to make room in the portfolio for this new position. TLT is shown in the chart below. This exchange-traded fund (ETF) has been in a long-term up trend. The Relative Strength Index (RSI) has been above 40 since April 2011. Until this indicator falls below 40, TLT should remain in an uptrend.
EMB has only been held by the system for two weeks, but it moved about 2.1% higher in that short time. The switch to TLT indicates that U.S. bonds should be stronger than emerging markets in the months ahead. This makes sense if the global economy slows, because we would see U.S. bonds benefit from a flight to safety.
The quick trade in the bond’s asset class is unusual, but it is important to follow the system’s rules rather than try to second guess the state of the global economy. By following these rules, the bond portfolio has delivered annual gains of 9.6% a year over the past five years while most other investments have been almost unchanged — not bad for “boring” bond investments.
– Michael J. Carr
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Source: Trade of the Week
