First 'Buy' Signal in a Year Shows Major Trend Might Be Ready to Reverse

Conventional investment wisdom is that stocks beat bonds in the long run. Like all of the other rules that everyone "knows" are true, this one depends on a variety of factors. Sometimes, bonds actually beat stocks in the long run, like they did in the 30-year period that ended in October 2011.

According to Bianco Research, long-term government bonds delivered an average gain of 11.5% a year while stocks gained 10.8% over that time. This was the first time that happened since 1861, according to Dr. Jeremy Siegel, an expert on long-term performance, although bonds have beaten stocks in shorter time periods.

Interest rates move in the opposite direction of bond prices, so as prices rose in the past 31 years, rates fell. This period actually marked a historic collapse in interest rates. In September 1981, 10-year Treasury notes offered annual yields of more than 15.8%. That rate fell as low as 1.4% in July 2012. Federal Reserve data shows that the trend has been steadily lower since 1990.

Eventually, this downtrend in rates should reverse, but of course no one knows exactly when. The next chart shows that the long-term trend could change soon. Interest rates have generally been a few percentage points higher than the rate of inflation (shown as the red line).

Since the financial crisis hit in 2008, this relationship has become less noticeable, which might be a consequence of recent Fed policy. In time, interest rates will probably move back above the inflation rate, and with the Fed targeting inflation of about 2% a year, that would indicate interest rates could double from current levels in time.

While rates may be moving higher in the years ahead, trading is about timing when that move could begin. Stocks attracted a great deal of attention last week, but interest rates also moved sharply higher as bonds fell.

An ETF that tracks long-term bonds, iShares Barclays 20+ Year Treasury Bond (NYSE: TLT), lost 3.98% last week. An inverse ETF that allows traders to benefit from a drop in bond prices, ProShares UltraShort 20+ Year Treasury (NYSE: TBT), gained 8.28%. According to the chart, TBT is now a buy for the long term.

The chart above shows that the stochastics indicator is bullish on the monthly and weekly time frames. After being oversold for more than a year on the monthly chart, this indicator has broken out of oversold territory. This is usually considered to be the trigger for a buy signal.


The weekly chart shows that TBT has developed a short-term uptrend and broken above resistance. A double-bottom price pattern shows a price target of more than $73.80 is reasonable in the next three to six months. If this is a reversal in the long-term trend, TBT could be held much longer and deliver even bigger gains.

The long-term trend in interest rates is likely to reverse when the Fed decides to change its policy. Over the weekend, two Federal Reserve regional bank presidents said they thought the Fed might stop its latest easing program later this year. Additional support for that idea came out of the minutes from the latest Fed meeting, which showed that several members of the Federal Open Market Committee (FOMC) thought it would "probably be appropriate to slow or stop purchases [of long-term bonds] well before the end of 2013." Many analysts expect interest rates to rise when the Fed stops easing. This would be a fundamental reason to buy TBT.

While it seems likely that TBT will go up in the near term, interest rates can be volatile and a stop-loss is important to manage the risk of this trade. If TBT closes below $63.14, or the 20-day moving average, this would indicate that rates are probably going to remain low for some time and the trade should be closed at a loss.

Recommended Trade Setup:
-- Buy TBT at the market price
-- Set initial stop-loss at $63.14 and then use the 20-day moving average as a trailing stop
-- Set initial price target at $72.80 for a potential 10% gain in 3-6 months

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