TBT is Not a Buy Yet

September 08, 2014, 12:32 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

Bond market investors are much smarter than stock market investors, they have longer term objectives, and they tend to do their homework much more carefully.  They also invest larger dollar amounts, so it should be part of ever equity investor's evaluation process to understand what the bond market is saying.

Treasury bonds have been rallying, and although last week saw the first real outflows from Treasury bonds in months, yields are still very low and global demand still seems high.  There are two ways of looking at this, one concerns domestic risk, and the other concerns direct comparisons to interest rates in the global marketplace.

But first, some larger investors have been vocal recently about their opinion on the recent bond market rally.  For example, Goldman Sachs (GS) is of the opinion that the bond market will significantly underperform going forward, and other large investors like David Tepper have suggested that the rally in the bond market is over.  If the rally is over it might be a great time to short long-term U.S. Treasury bonds, and one of the best ways to do that is to use ProShares UltraShort Lehman 20+ Yr(ETF) (NYSEARCA:TBT)

However, before you go there you must recognize why longer term U.S. Treasury bonds have been rallying.  There are two reasons, and one is domestic.

This first reason concerns risks to the U.S. economy as FOMC policy begins to tighten.  Individual investors might argue that the FOMC is still highly accommodative, but the truth is that FOMC policy is tightening liquidity and the combined efforts of the U.S. treasury and the FOMC are now a drain on liquidity in the Financial System.  This opens the door for economic risks that were unfathomable last year and it creates concern in the circles of smarter money that discount the hype and the euphoria that riddle smaller investor communities at this time.

Those smarter investors are concerned about the domestic risk that lies ahead and they consider longer term U.S. treasury bonds to be a safe haven.

In addition, a second catalyst exists and that stems directly from global economic concerns.  The global economy, especially European Economies, appear fragile, and that risk is enough to influence larger investors from those countries to look for safe havens in government bonds.  In fact, government bonds in European countries offer yields that are much less attractive than the yield we see now on the long-term U.S. Treasury bond.  That means that even though interest rates are very low on our side of the pond, they are actually quite a bit higher than the interest rates in other countries.  That makes the long-term U.S. Treasury bond attractive to foreign investors, and when the recent strength of the dollar is factored in that seems to help as well.

Therefore, there are two factors influencing the demand for U.S. treasury bonds at this time.  The first is domestic as FOMC monetary policy continues to tighten and the combined efforts of the U.S. treasury department and the FOMC continue to drain liquidity from the Financial System, and the other comes from foreign investors and their interest in U.S. treasury bonds.

Although at first glance shorting U.S. treasury bonds seems like a very interesting proposition, there are no current signs to buy TBT according to our real time trading report for TBT.  Instead, that ETF appears to be in a steep downward sloping channel and until such time as it breaks that channel investments in this ETF should be avoided.

Ultimately, price is all that matters, and in this case the price of the ETF is what matters most to us, but I will add one more additional catalyst to this story.  Our longer-term macro economic analysis is called The Investment Rate and it predicts longer term economic cycles.  It suggests that the underlying economy is much weaker than it appears to be on the surface and if that is true the underlying risks that exist domestically are much higher than anyone seems to think at this time.

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