Should You Buy the Pullback in Treasury Bonds?

Source: Thinkstock

Source: Thinkstock

Surprisingly, one of the best performing assets year to date has been U. S. Treasury Bonds—long term bonds in particular. At the end of 2013 this was one of the most hated assets in the market: It seemed that no matter what your conviction that it followed that Treasuries had to decline in value.

If you were bullish of stocks, it meant that there was going to be a “great rotation” out of bonds and into stocks. It also meant that the Federal Reserve would continue to taper its quantitative easing program, and that this would mean that the largest buyer of long-term Treasuries would be buying less of them.

If you were bearish, then the Fed would continue its bond buying program, but it also meant that inflation would increase and that Federal tax receipts would decline, and both of these phenomena would put downward pressure on bond prices.

Despite this bonds have outperformed U. S. stocks and commodities. If you look at the iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) it is up nearly 10 percent year to date, and the gain is larger if you count the $1.38/share in interest payments it has made. But over just the last few days—after bond prices hit their highest level in almost a year—the fund has suffered a mini-crash, having fallen from a high of about $115/share on Thursday morning to a low of $111.50/share late Tuesday. Now it normally isn’t a big deal when an asset loses just over 3 percent of its value, but considering that long-dated Treasuries are considered to be “safe” and not so volatile, one has to take notice and wonder whether the run-up in the bond market has ended.

It is very easy to make the case that the run-up has ended for the simple reason that the bond bears were right on the fundamentals. They were simply wrong on sentiment, which had gotten so negative that the bond market simply had to rise, if only to squeeze the shorts and to force the bears to question their beliefs. Technically, however, the long-term bond market is still making higher lows and higher highs. It is also trading above its key moving averages.

Given the strong chart pattern, I would argue that the long-dated Treasury Bond trade is still intact, and that the pullback we have seen offers traders an entry point.

But for those investors looking to take a long term fundamental position the Treasury Bond market is a terrible place to be. Historically yields are incredibly low: Fundamentally U.S. Government Bonds have been attractive when they offer much higher yields—in some cases greater than 10 percent!

Furthermore, the bull market in bonds has been going on for an extremely long period of time. The last bond bull market began back in the early 1980s, which means that the bond bull market is over thirty years old. Historically bull markets rarely last that long. For instance the last stock bull market lasted from 1982 through 2000, or less than twenty years. The last gold bull market lasted from just 1971 through 1980.

So herein lies the conundrum. It seems that everybody is bearish of bonds because there are so many obvious reasons to be bearish of bonds. But everybody is therefore on the same side of the trade, and in such situations it often makes sense to take the opposite side. The safe or the “easy” strategy is to simply stay out of the bond market and go neither long nor short.

If you are more aggressive and are willing to switch your position and check your emotions at the door, it seems that the best approach in this market is to be long of bonds. But make sure you limit your position and use stop orders. Another good strategy might be to buy call-options on the TLT, which have fallen in price over the past couple of days with the market. This way you can participate to the upside while limiting your market exposure.

Disclosure: Ben Kramer-Miller has no position in the TLT.

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