October 20, 2023
By Steve Blumenthal
“The world’s most crucial benchmark market is on an unpredictable journey with an uncertain destination.”
– Mohamed El-Erian is President of Queens’ College, Cambridge University, an advisor to Allianz and Gramercy, and a best-selling author. He previously served as Chief Executive and Co-Chief Investment Officer of Pimco, Deputy Director of the IMF, and President and CEO of Harvard Management Company.
That was the title of an article I wrote for Forbes in May 2014. The editor was the creative fellow who came up with the title. The message was simple: Risk was greater than potential reward. The title painted a good visual, though it turns out that “soaked” may have been too gentle of a word to describe the depth of the post-bubble losses that we are seeing today.
Setting the stage for the events that preceded, let’s go back in time.
• November 2008: QE1 – In late November 2008, the Federal Reserve started buying $600 billion in mortgage-backed securities. By March 2009, it held $1.75 trillion of bank debt, mortgage-backed securities, and Treasury notes. This amount reached a peak of $2.1 trillion in June 2010 at which point further purchases were halted as the economy started to improve. Purchases resumed in August 2010 when the Fed decided the economy was not growing robustly.
• November 2010: QE2 – In November 2010, the Fed announced a second round of quantitative easing, buying $600 billion of Treasury securities by the end of the second quarter of 2011. The expression “QE2” became a ubiquitous nickname in 2010, used to refer to this second round of quantitative easing by US central banks.
• September 2012: QE3 – A third round of quantitative easing, “QE3”, was announced on September 13, 2012. In an 11–1 vote, the Federal Reserve decided to launch a new $40 billion-per-month, open-ended bond purchasing program of agency mortgage-backed securities. The Federal Open Market Committee (FOMC) also announced that it would likely maintain the federal funds rate near zero “at least through 2015.” Because of its open-ended nature, QE3 has earned the popular nickname of “QE-Infinity.”
Here’s what I wrote in my Forbes article in May of 2014:
“Most investors are unaware and ill-prepared for the impact that rising interest rates will have on their bond funds and ETF investments. There has been an unprecedented period of Fed participation (manipulation) with six years of near zero-percent interest rate policy and trillions of newly created currency.
“The Federal Reserve is waging a battle against deflation. Deflation can lead to depression. The Fed’s objective is to create inflation. Our risk is that they do not succeed. Unfortunately, our risk is also that they do succeed.”
I suggested a trading process to navigate periods of rising interest rates. I say “trading” because nothing is ever a straight line in this business. What was clear then was that the reward of earning a 2.50%-per-year yield was small relative to the risk of losing so much more. I concluded the article with the following thought:
“It has been a 30-year bull market for bonds. In order to be successful moving forward, investors need to be smarter and more flexible in their approach. It is the change in the interest rate trend we must consider as we view portfolio risk. The Fed and other central banks are doing all they can to create inflation, and they are armed with considerable resolve. With interest rates near historical lows, it is inflation and rising rates that present considerable portfolio risk. It is time to tactically trade fixed income exposure. The bubble of all bubbles may just be in bonds.“
The Final Blow?
• March 2020: QE4 – QE4 came because of the economic impact of the COVID-19 pandemic. The Federal Reserve began conducting its fourth quantitative easing operation since the 2008 financial crisis, and on March 15, 2020, it announced approximately $700 billion in new quantitative easing via asset purchases to support US liquidity in response to the pandemic. By mid-summer 2020, there was an additional $2 trillion in assets on the books of the Federal Reserve.
• They’ve printed approximately half of all the dollars printed in the history of the republic in just the last few years.
• Another round of Fed and fiscal liquidity is likely in the next recession. But everyone’s lights are turning on. The Fed may be within five years or so of running out of runway – nearing the final blow.
I believed that in 2014, the Fed would win its war on deflation and usher in a period of inflation. Sadly, that proved correct, and I believe the problem will persist and deepen as our deficits and debt continue to grow.
Let’s zoom out and look at the bigger picture.
Below is a chart looking at the history of interest rates going back to 1962, specifically plotting the 10-year Treasury yield. I added a few orange arrows/dates. You can see that my May 2014 bond market bubble warning was early. Rates declined from 2.5% to 2%, then climbed back above 2.5% in 2018. I kept writing that inflation is the kryptonite to Fed policy, if you recall. The Covid crisis brought the helicopter money, and now we’re seeing the consequences: inflation and the bond bubble bursting.
The popular Vanguard Extended Duration ETF, which owns long-term maturity US Treasury bonds, has dropped more than 60% in the last two years. That exceeds the stock market declines of 2000-2002 and 2008-2009. Many view Treasury bonds as a “safe” asset class. Nobody thought safe Treasury bonds could be down that much. They’re not so safe after all.
Here’s another chart for you:
May 13, 2014, to 10-19-2023:
May 13, 2014, to 19-19-2023:
- The chart above shows the bond rates between May 13, 2014, and October 19, 2023:
- EDV in navy blue: -60% from its 2020 high
- TLT in light blue: -48% from its 2020 high
Compare the declines to the -55% S&P 500 Index crash during the Great Financial Crisis.
I don’t think most people are aware of the depth of the decline in Treasurys. Replace your coffee this week with some weights so you can burn off the steam that might be building up inside. One more chart.
What Can You Do?
With the Vanguard Extended Duration U.S. Treasury ETF (Symbol “EDV”) down 60% from its high, you might be thinking now is a good time to trade. I know I’m getting interested. I think we’re in an environment that favors active trading vs. buying-and-holding 5% yielding Treasury Notes and longer-duration Treasury bonds. A short-duration 5% Treasury bill is a good choice as it gives you instant liquidity to take advantage of trading opportunities.
What’s the investment process? We turn to the late, great Marty Zweig and Ned Davis Research (NDR).
Marty was a renowned American investor, financial analyst, and author. He was known for his insights into the stock market and his ability to predict market trends. His most famous work is often associated with his book, Winning on Wall Street, in which he discussed his approach to stock-market analysis. I shared his investment process in my Forbes article.
NDR, for its part, is an independent research shop serving institutions, family offices, advisors, etc., cofounded by Ned Davis. Ned and Marty were friends. My firm has been a subscriber and fan of NDR since the 1990s. Around ten years ago, one of Ned’s research pieces detailing the Zweig Bond Model caught my eye. Our firm then engaged NDR to do some custom work to create an automated, working version of the process. It updates daily.
The model is a technical, trend-based model designed to trade the bond market. I look at it frequently to understand the dominant trend/direction of interest rates better. We don’t run a specific trading strategy around the signals, but the model does help us with our broader understanding of risk and reward. Namely, rising interest rates are bad for traditional fixed-income and equity investing, and falling interest rates are good.
Few things are as important as the price of money, and the level of interest rates largely determines that price.
Now, you can put down those weights, grab that coffee, and put on your favorite geek glasses.
You’ll find the rules for the Zweig Bond Model (below if you are reading online), or click through on the large blue button if you are reading via email. To the best of my knowledge, the rules have remained in place since the 1980s. While no process is perfect, this one has served me well in real life—particularly in 2019 when 24 out of 24 Wall Street analysts (Barrons survey) and I believed interest rates would rise. The Zweig Bond Model signaled the opposite. Fundamentally, I’m getting excited about a nice Treasury Bond ETF trading opportunity today. But the model and Mohamad El-Erian are saying, “not just yet.”
Here are the sections in this week’s On My Radar:
- Mohamad El-Erian – U.S. Bond Market is Losing It’s Strategic Footing
- The Zweig Bond Model Explained
- Random Tweets
- Personal Note: Old Sandwich Golf Club
- Trade Signals: Weekly Update, October 18, 2023
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Mohamad El-Erian – U.S. Bond Market is Losing It’s Strategic Footing
El-Erian wrote an excellent piece in the Financial Times. You can find it here.
It is about how the problem in the U.S. Treasury Bond market is more than inflation and the Fed’s playbook. The U.S. Treasury market is the most important asset in the global financial markets, and it is losing its standing. Following are my bullet point notes. I encourage you to read the full article.
- Economic growth forecasts for the US have been inconsistent, ranging from a soft landing to a hard landing.
- Uncertainty surrounds Federal Reserve policy, including questions on the impact of rate hikes, balance sheet reduction, and the absence of an effective monetary policy framework.
- The situation is exacerbated by substantial fiscal deficits that show no sign of moderation, partly due to Congressional dysfunction and expenses related to past commitments and responses to critical challenges like climate change.
- There is uncertainty about who will absorb the additional supply of government debt resulting from high deficits, as the Federal Reserve, a major buyer in the past, is now selling bonds, reversing its quantitative easing.
- Foreign buyers are hesitant, and domestic institutional investors like pension funds and insurance companies hold bonds with mark-to-market losses. Concerns about regional bank deposits’ stability could lead to bond selling.
- Short-term stabilizers still exist in the bond market, with surges in yields attracting buyers and drops in yields allowing investors to mitigate paper losses. Despite these stabilizers, the bond market’s resilience should not be taken for granted.
- The world’s most crucial benchmark market is on an unpredictable journey with an uncertain destination.
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
The Zweig Bond Model
Here is how this particular tactical trend following process works:
- Score a +1 when the Dow Jones 20 Bond Price Index (index symbol $DJCBP) rises from a bottom price low by 0.6%. Score a -1 when the index falls from a peak price by 0.6%.
- Score a +1 when the Dow Jones 20 Bond Price Index rises from a bottom price by 1.8%. Score a -1 when the index falls from a peak price by 1.8%.
- Score a +1 when the Dow Jones 20 Bond Price Index crosses above its 50-day moving average by 1%. Score a -1 when the index crosses below its 50-day by 1%.
- Score a +1 when the Fed funds target rate drops by at least ½ point. Score a -1 when the rate rises by at least ½ point.
- Score a +1 when the yield difference of Moody’s AAA Corporate Bond Yield minus the yield on 90-day Commercial Paper Yield crosses above 0.6. Score a -1 when the yield difference falls below -0.2. Score it 0 for a neutral score between -0.2 and 0.6.
- Add up the sum total of steps 1 through 5 once a week (the chart below reflects Friday’s close calculations).
- If the total sum is +1 or higher, invest in a bond or bond market ETF like “BND” (the Vanguard Total Bond Market ETF) or “AGG” (iShares Barclays Aggregate Bond Index ETF). More aggressive investors may consider “TLT,” the iShares 20-year Treasury Bond ETF, or “EDV,” the Vanguard Extended Duration Treasury ETF.
- If the aggregate score is -1 or lower, reduce your portfolio risk by shortening the maturity and buy NYSE: BIL (SPDR Lehman 1-3 Month T Bill ETF).
Here’s how to read the chart:
- The current signal is highlighted in yellow (lower right-hand section of chart)
- The scoring is ranked in the center section. The current score is -2.
The returns are hypothetical returns and do not reflect actual trading performance. See important disclosures below. PLEASE NOTE that my firm does not run a Zweig Bond Model trading strategy. We use it to gauge market risk and inform our overall macro thinking. The ZBM chart is updated each week in Trade Signals. It remains in a sell, signaling higher interest rates.
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
Yes – Follow Jim Bianco!
Yes – Follow Peter Boockvar!
Magnificent Seven – Rymes with 1999
Debt and Interest
Follow me on X (formerly Twitter) @SBlumenthalCMG
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Personal Note: Old Sandwich Golf Club
Sunday morning, I fly to Boston, then drive an hour south to Cape Code—designation – Old Sandwich Golf Club. A giant pre-golf thank you to Ben B.
Old Sandwich Golf Club was been founded in 1892, making it one of the oldest golf clubs in the United States. Architects Bill Coore and Ben Crenshaw redesigned the course in 2004. It’s on my bucket list and is considered one of the top golf courses in the United States.
I did some searching to see if there was a fun story to share. Not sure if this is true, but if so, I’m gonna get myself a bite of that O’Reilly’s famous sandwich. From ChatGPT, the story goes like this:
“What set this club apart was not just its age; it was the legend of the mysterious old sandwich that was rumored to be hidden somewhere on its grounds.
The story went that during the club’s early days, a passionate golfer named Harold O’Reilly had a habit of bringing his lunch to the course. He was known for his unique sandwiches, created from a secret family recipe handed down through generations. These sandwiches were said to be so delectable that they had the power to improve a golfer’s game.
As the years passed, Harold’s sandwiches became legendary, and members of the club would often try to replicate them. But no one could quite capture the magic of the original sandwich, and Harold refused to share the recipe with anyone.
When Harold passed away, he left behind a riddle that hinted at the location of his secret sandwich recipe. It was said that the key to unlocking the recipe was hidden somewhere on the golf course.
For decades, members and visitors alike searched for the elusive riddle’s solution. They scoured every nook and cranny, dug up sand traps, and explored the dense woods that bordered the course. But the secret remained hidden, and the recipe stayed locked away.
Then, one fateful summer day, a young caddy named Emma was cleaning out the club’s old storage shed. Amidst dusty golf clubs and forgotten relics, she stumbled upon an old leather-bound journal. Inside, she found Harold’s handwritten notes, filled with cryptic clues and hints about the location of his secret sandwich recipe.
With the journal in hand, Emma embarked on a quest to unravel the mystery. She followed the clues through the ancient oak trees and along the babbling brooks of the golf course. Each clue led her closer to the ultimate prize—the legendary recipe that had eluded so many before her.
Finally, after months of sleuthing and countless rounds of golf, Emma stood before an old oak tree with a gnarled, hollowed-out trunk. Inside, she discovered a weathered piece of parchment that held the coveted recipe for Harold’s magical sandwich.
Word of Emma’s discovery spread throughout the club, and members gathered to taste the sandwich that had become a legend. As they savored the unique blend of flavors, they couldn’t help but feel that their games had improved, just as the story had promised.
From that day forward, the Sandwich Golf Club not only boasted a storied history but also a legendary sandwich that brought golfers from far and wide. The club’s secret was no longer hidden, and golfers now knew that a round of golf at the Sandwich Golf Club was not complete without a taste of Harold O’Reilly’s famous sandwich—a secret that had finally been shared with the world.”
Coach Sue and the Team
The team has 4 wins, 8 losses, and 1 tie, and we sit last in its division. I guarantee you it is not the head coach. Her opposition analyst assistant, me, has to take a hard look in the mirror. Spirits remain high, and as I type these last few words, I’m sending the letter to the team to get it posted and sent to you. Go Friars…
AND GO PENN STATE. There’s a big game vs. Ohio State tomorrow at noon.
Still praying for peace…
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Trade Signals: Weekly Update, October 11, 2023
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Notable this week:
- Equity markets declined today, giving back recent gains. The S&P 500 Index fell 1.3%, the Nasdaq was down 1.6%.
- I’ll be writing about the bond market in Friday’s OMR. It was another tough day for bonds. The 10-year Treasury yield soured to another 16-year high. The yield closed at 4.90%. We can’t rule out the mid-5 % range.
- The Zweig Bond Model remains in a sell signal. Signaling an uptrend in yields.
The dashboard of indicators and the stock, bond, developed, and emerging market charts, along with the dollar and gold charts, are updated each week. We monitor inflation and recession as well. If you are not a subscriber and would like a sample, reply to this email, and we’ll send you a sample.
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The views expressed herein are solely those of Steve Blumenthal as of the date of this report and are subject to change without notice. Not a recommendation to buy or sell any security.
With kind regards,
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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