While we touched on this topic yesterday, we thought it was so important that it warranted a follow-up.
We recently received a major sell signal in the US Treasury Long Bond. Our bond momentum indicator has rolled over from overbought levels giving a sell signal. While this indicator could reverse back up, this kind of action in the bond momentum indicator (rolling over from extremely overbought) is usually a strong confirmation that the bottom is already in for yields.
Years ago, we started back-testing a momentum formula developed by an English Gentleman named Coppock. He actually used this formula primarily for the stock market. Our research revealed it had some merit for stocks, but for the bond market, it was fantastic. It is our primary tool to determine our bond exposure.
The chart below shows the yield of the 30-Year Treasury, with the Long Bond Momentum Indicator beneath it. The lines show every reversal in overbought territory since 1982.
You can see when the Long Bond Momentum Indicator moves to extreme levels on both sides of the scale and then reverses, it has generally been an amazing time to buy or sell longer-term Treasuries. When the momentum does shift, it can pay big rewards to shift your investments with it.
Bond yields have most certainly been distorted with the Fed purchases and a massive flight to safety in international reserves. Our momentum gauge is very negative for current bond yields, but we restate our belief that bond yields, or inflation, are not going to reverse that declining trend of the last 30 years.
The 30-year Treasury has now mapped out a terrific long-term trend line since 1985.
We certainly don't expect a sudden rise in yields above the 4% level, but if we are correct about the future reduced volatility, high productivity, and less defense spending, with an emphasis on promoting growth, then this yield should move back to the top of that trend channel in the next 12-24 months, and with it, Long Bond prices will drop fairly significantly.
While this is bearish for bonds, it has very bullish ramifications for stocks. Low bond yields often mean a weak economy, and vice versa. So the vice versa thought of a strengthening economy is very bullish for stocks.
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