With the 30-Year Treasury rate flirting with lower-yields, investors should prepare their bond portfolio for a sudden all-new high in Treasury prices. As stock markets hit highs, bond market investors continue to believe that yields will head lower. Bond yields are taking their cue from the recent coronavirus risks, an accommodating Federal Reserve, and a nervous oversea Treasury buyer. According to Citi, other buyers such as Taiwanese insurers are driving structural demand for long-dated Treasuries. These international buyers still view the U.S. as their choice of safety for government bonds. Another factor to consider along with global risks is the current state of inflation. A core measure of U.S. inflation released Thursday showed inflation pressures slowing to an annualized 1.3% in the fourth quarter, from 2.1%, in the latest inflation reading. These factors are pushing long-term yields lower, and record high U.S. Treasury prices that investors haven’t seen, yet.
How To Profit From Lower Rates
The iShares 20+ Year Treasury ETF (TLT) is hitting record highs, and is the preferred ETF of choice when speculating on lower long-term rates. TLT seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than 20 years. According to iShares.com, the ETF has a 30-day yield of just 2.01%. However, the yield is not what the bond investor should be focusing on. The potential future price appreciation is what we are focused on here.
With TLT prices hitting new highs, I find the trend is your friend. If equities suffer from a short-term pullback or deeper correction from the above outlined risks, TLT could see even higher prices as investors look for safe havens. Year to date, the TLT is +6.71%, while the S&P 500 is only +.84%. It’s possible to receive equity like returns in the fixed income market by purchasing funds like TLT in speculation of lower interest rates.
Assets Are Swelling In TLT
With more than $19 billion in assets under management, TLT is very liquid with an average of 15 million shares being traded. Investors looking for safety continue to purchase TLT, as demonstrated in the below chart:
Assets have been continuing to swell into TLT with just $6 billion under management in 2015, to $19 billion in 2020. With an equity market at new highs, TLT continues to gain assets and increase in price. A peculiar situation is the two asset classes working currently together, when historically they have worked against each other in a negative correlation.
At least since 2017, the TLT is trending higher along with stocks. Investors who are building a balanced portfolio want to see TLT have a direct negative correlation with equities. I continue to believe that the negative correlation of treasuries to stocks will happen again, and long-term treasury rates are heading for 1%. Regardless of correlations, U.S. Treasuries are still the preferred home for capital as global fears of coronavirus and global risks of deflation continue to push yields lower.
Risks To Consider
The primary risk to consider in owning the TLT is the timing of the trade and if rates will continue their rapid decent. Given that the Treasury market is in a 40-year bull market of higher prices, I can’t see this trend suddenly changing. One should note that TLT is a pure beta trade on lower rates. If inflation was to suddenly spike out of control, TLT would be the last ETF you would want to own. However, we discussed above that inflation is under the 2% mandate target for the Federal Reserve. This risk is under control, and actually causing the Fed to continue on with easier monetary policy. Investors who believe inflation will increase usually demand higher yields to offset its effect. This inflation price growth usually comes from a strong economy – an upward-sloping curve generally means that investors have higher expectations. However, we continue to see the yield curve move between inverting and upward sloping. Something will have to give here between 1.5% short-term rates and long-term rates of 2%. As long as inflation is tamed, I do not see the Fed reversing course and hiking short-term Fed Funds rates again this year.
Looking Forward With Treasuries
Capital continues to flow into TLT and long-term Treasuries, even as stocks hit new highs. One pure and simple way is to allocate part of your fixed income portfolio in owning Treasuries through the iShares TLT. With its 7.35% year-to-date gain, we could see the long-term Treasury become one the best ETF trades in 2020. With global risks rising such as coronavirus, and inflated stock market levels that President Jerome Powell mentioned in the latest Fed minutes, TLT could be a good short-term fixed income trade. The investor should pay close attention to global risks, inflation measures, and own TLT accordingly. Within your balanced portfolio, consider the iShares 20+ Year Treasury ETF as your protection trade from lower interest rates and lower stock values.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TLT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The above statements are opinions of Mr. Josh Ortner, CTFA, and should not be construed as personal financial advice.