Shorting the Final Frontier (FM, TYX)

Gonna to take a moment to discuss the bond market, which, if you’ve been paying attention, has not rolled over and played dead as fast as we said it would.

Remember, we’ve been of the opinion that the bull market in bonds – a thirty-year affair that brought long yields down from over fifteen percent to two and a half – has ended and that owning these securities as a long-term investment was a losing proposition. For those who want to trade the swings in the Treasury market, go ahead. We wish you the luck of the Irish. We just warn you not to be in it for the long haul.

30yrtreas

And yet the bond market has defied us. Since New Years, the yield on the 30-year has fallen from 4% to a recent 3.26%, a move that has led many to reconsider their position vis-à-vis the profit making potential of Treasuries.

Here’s a chart of the most recent moves on the long bond –

tyx

This is two years worth of data for TYX, the CBOE’s thirty year interest rate index.

As you can see, the latest retracement (in red) is but a blip on the longer-term chart, but in this high-speed, microwave Intel processor world in which we live, five-months feels like an eternity.

So folks change their minds. And they think bonds are still a bullish investment.

But not us.

Sure, we’ll have inflows into the long bond while diminishing yields in Japan, Europe and elsewhere continue to put lipstick on our thirty-year Treasury pig. So, too, as foreign cash flows push into the U.S., chasing our equity and real estate markets higher, yields will also be pressured lower. And as evidence of domestic economic strength also grows, the tendency toward bonds will also be reinforced, particularly among foreigners seeking safe harbor from the uncertainties of Europe and the Middle and Far East.

But it won’t last forever.

Because all that cash racing to our shores will ultimately create an inflationary swell that the bond market will be incapable of ignoring. Regardless of the Fed’s intentions or actions or jawbonings – at that time, the bond market alone will decide. And it will do so by selling.

As for the above chart, technically, the bottom may already be in. Long yields found support at the long-term (411 day) moving average, in yellow, and have bounced higher in the last two weeks. In so doing, they’ve also cut above the down-sloping trendline from the former highs in January (in red). And that, too, should be construed as positive.

The real test, of course, will come when yields bump up against the downtrending 137-day moving average. At that point, we’ll expect a fight.

Altogether, then, we haven’t given up on the bond bear. We believe it’s still in force, though early days are always hard to read. Whenever a stock or asset class makes a secular change of trend, volatility, misdirection and dislocation make it hard to analyze.

Easier to Analyze

We’re going to recommend you take a look at the following sector for a possible trade today, for the simple reason that it’s had a whale of a ride for several years and we now believe the bullish tide may be ebbing.

overseas

You remember the emerging markets roller coaster of earlier this year? It actually started in early November of 2013, when interest rate hikes on the part of several up and comers (India, Brazil, South Africa and Turkey) put the jolt to investors in those countries and sparked a selloff in their equity markets that led to investment flows burgeoning back to the U.S.

Thankfully for those nations, things have recovered. But what was more interesting for us through it all was just how insulated the so-called ‘frontier markets’ were from the selling.

Take a look here –

fm

Frontier markets include countries at a less advanced stage of economic and market development, nations like Bangladesh, Estonia, Jordan and Kuwait, among others, where both investment returns and risks can be larger than normal.

FM is the MSCI Frontier 100 ETF, a well-traded proxy for the group that’s listed on the NYSE.

The chart speaks for itself – a 50% rise in a year and a half and barely a peep during the 2014 Emerging Markets swoon that had many believing the entire financial edifice was about to give way. The frontier markets actually advanced during that period!

But they now look expensive.

A near parabolic rise (in red) accompanied by a volume burst and an 80+ reading on the RSI (in blue) tell us this dude’s a short.

Dump it. Or pair it with an index, long/short.

Many happy returns,

Matt McAbby
Senior Analyst
Normandy Research

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