Notes, Bonds Surge to Continue?

Interest rates surged this week reportedly on investor nervousness regarding the potential credit downgrade as well as the mounting debt that the US Treasury is issuing. Neither story is new. If you have been following the Asset Design Center blogs all year, you will have noticed that we have been positioned for such market turmoil from the very beginning. Just like the laws of nature, economic and finance laws are universal and are bound to eventually catch up with the marketplace.

The above chart is a weekly chart of the ProShares Ultra Short 20+ Year Treasury Bond (TBT). It is the instrument that we have been using in our stock portfolios as a core holding. While the chart is weekly, notice how powerful the three-period idea can be. After making lows in December, TBT came back down in March establishing a three-month test of the low.

SPX Making a Different Pattern

The stock market also tried to test the lows in March but failed. While the market has rallied since then, it has not risen above previous lows and my feeling is, an untested market is an unsafe market. Our stock portfolios have been 35% in cash and many investments have been in equities that are sensitive to the decline in the dollar such as gold, oil and the Pro Shares Bearish Dollar Fund (UDN). Other stock positions have been established as buy/writes at the beginning of the year. Volatility was so high at that point that almost all of our stocks would be able to weather a 35% decline in the stock price without our position losing money.

I've got to admit, reviewing stocks this weekend in preparation for possible actions at the end of this new week, I was surprised that so many stocks are still on a run.

Potash (POT) is one example of a stock that is powering ahead. Notice how this stock also made the important three-month test of the low. The stock has nearly doubled from the testing point. It demonstrates the validity of the basing process that I have been discussing over and over again. You don't need to pick the absolute bottom to make a ton of money. I can sleep much easier when I see such a test of the lows be successful. And when I have doubts, I sell a long-term call option against the position. Most of the buy-writes that we put on at the beginning of the year stand to make a 50% profit should the stock price rise or do nothing. Those kind of returns are pretty good. And the option sale gave us extra income to hedge ourselves on the downside should the market go against us.

Potash was one of such holdings. We purchased POT at 73.22 and sold the January 09 call at 22.70. At this point, our net profit on the position is greater than 30% for a five-month holding period. With only 3 points of premium remaining on the position, we may close the position out and build up some cash in the event that the market will decline. There are many, many stocks that appear ready to fall apart and I would like to have cash on hand and be ready to pounce when the opportunity is right

Don't Need To Be Greedy

Asset Design Center clients know that our format is to build portfolios that provide you with the required rate of return with minimal volatility. It is not our goal to make 100% on your money each year but to achieve your financial objectives through consistent year-to-year steady growth with minimum volatility. If you have extra money available that isn't in your goal saving plan, you can use it to "rock and roll." Our relatively conservative options on futures accounts are up nearly 30% this year. There is always room to "rock and roll" after all of your important objectives are met. Even though we like to think that our futures ideas are conservative, just as the realities of higher levels of debt are sure to cause a lower debt rating and higher interest rates, earnling 5% to 10% each month is also beyond the realm of normal expectations. There is always that once or twice events in a year that can destroy your gains if you are not experienced enough to know how to work our way out of it. .

TIME TO PARTY

While the wonder as to what North Korea's nuclear gamesmanship will have on the world markets tomorrow, the day will be set aside for enjoying the day. As a Viet Nam era veteran, and a disabled one as well, I choose to spend the day with other vets and friends before returning to the real battle when electronic trading begins tonight! Have a great day and enjoy.

Possible Rate Retracement

Rates have had a nice runup over the past several months but may be due for a little backing and filling. A logical place for the 10 year rate to fall to is the 3.04% level. Notice how this point meets the rising 4 week moving average. It also marks the previous closing high set several months ago.

Rates have the potential to decline even more depending on how the market reacts to the bank stress test results and the much awaited unemployment report. We all know the numbers aren't going to be pretty. The unemployment number has the potential to really rock the world though since a major assumption in the stress test review is the future unemployment rate. Should the unemployment number indicate that the government's worst case unemployment scenario is too conservative, rates could drop significantly.

Until further evidence shows that rates will again continue in their major decline, I'm still looking for much higher rates in the future.

One must try to understand what the Fed might be thinking as well. Their note and bond purchases have not met the market's expectations. Does the Fed think that rates will fall on their own? Or are they looking for higher levels to sell at?

The May edition of Trendsetter is now available. Write me at gary@assetdesigncenter.com to get on our mailing list.

Rates Rise - Where's the FED?

Prices on the June 10-year Treasury Note contract fell today as economic data was not as bad as expected. Also exacerbating the situation was a lack of buying on the part of the Federal Reserve. Notice the big spike up several weeks ago when the Federal Reserve announced that they would buy $300 billion of long term treasury securities. With the exception of the recent pop in prices that we predicted in earlier blogs note prices have since been retreating and are almost back to the Pre-Fed announcement levels.


I was a day early in our closing out the short put positions. Today I was happy that I had closed out the short puts the other day. Today I was in a good position to sell puts for a good premium. For risk management sake, I only have one short put and one short call position for each $10,000 invested.






Currently, the 10-year rate is at 2.94 at 12:45 central time. It is breaking out of the pennant formation and could advance on to the top of the price channel. By selling some out of the money puts, I'm am betting that the rate will back down into the pennant by the end of the day. Still volatility levels are low and even with all of the supply concerns and good earnings reports that are coming out; it's important to keep in mind that bank earnings might the products of manipulation and are not as good as they are now appearing. While rising interest rates (and falling note prices) indicate that the economy is gaining strength, I'm not quite yet buying it.

Bond prices might rise early next week one more time before falling. I wonder though how high the Fed will allow rates to rise before stepping in to drive rates down. While I expect rates to rise much higher in the long term, the threat of Fed intervention is always present. While this is disappointing for trend followers, it should present good trading opportunities. As such, with stochastics at the low end, I am taking the chance that prices will rise from current levels, providing a profit opportunity for the new short put position. I will also have the opportunity to establish a short June call position since the May options expire next Friday.

Ten Year Notes Set to Rise This Week

Ten year treasury yields rallied sharply last week despite less than favorable economic news. Unemployment numbers continue to rise and other data points continue to be negative. But despite poor economics, both the stock market and interest rates rose.

As mentioned last week, we were short both calls and puts on the futures. The rise in rates caused the future to drop sharply, making our May 126 strike calls virtually worthless. The positions were closed out winning nice profits.



The chart above shows the weekly interest ten year rate while the chart below shows the June ten year note futures contract. In examining the charts, notice how we may be setting up for a decline in rates and a rally in the futures. You can see that in the rate chart, the moving average is still declining pretty quickly. While rates advanced above the trend line, I would say that it's still too soon to play rates to go up. But the picture may change next week.

Looking at the futures chart, you can see the three-period pattern developing here. I would expect note prices to rally and try to take out the highs of three weeks ago. And, perhaps the rally will break through the double top and accelerate to still higher highs.

With this in mind, I purchased May 125 calls near the close of the day on Friday. I am also short puts so the position is very bullish. Should we fail to take out the previous highs or if we don't close above the closing price three weeks ago, I'll probably be reversing my position, expecting a big drop in notes.

On the positive side, as I mentioned in earlier blogs, it seems that interest rates and the stock market are starting to be correlated. If this correlation should hold true, expect the stock market to fall some this week. But this might be the last chance we have to get on a move that could take the market substantially higher.

Interest Rates Set For Upmove

INTEREST RATES SET FOR UPMOVE

Monthly Report - Part 2

Long-term interest rates fell in March but as the chart of the 10-year interest rate index (TNX) illustrates, the rate found support at the 4-month moving average and appears to have successfully completed a three-month-test of the lows. With this in mind, we need to be looking for an entry position to be short treasury bonds and notes. For those with a heavy bond allocation in their investment portfolios, be sure to have your adviser monitor this and shift out of long term bonds to a shorter maturity or cash.

On a shorter-term outlook, the 10-year rates appear to be continuing to head lower so you may wish to hold off before making a decision. I will watch it closely so you can monitor the blog to see when I take action. As the weekly note rate chart below shows, the rate has been hitting overhead resistance and appears to be headed lower.




Lower rates seem to be the normal thought now as employment numbers continue to worsen and the potential bankruptcy of General Motors and Chrysler weigh heavy on the market. First quarter earnings will be coming out as well. While few have high expectations for improved earnings, reports coming in at worse-than-expected levels could send shivers through the Treasury markets, especially considering the rosy reports banks were giving recently, telling the public that January and February were profitable months. The final wildcard is the Fed. What kind of impact will their purchases add on rates?

The weekly chart illustrates the persistant downtrend on rates with significant resistance coming in at the 2.83% and 2.91% levels making it hard to reconcile the monthly chart showing the potential for a directional change in rates. But it could happen. In general, the treasury market is spooked by the heavy supply of bonds, notes and bills that are continually coming into the market to support the trillions of dollars in spending that President Obama is proposing. When this thought prevails, rates rise. Another factor that cannot be ignored is the G20 meeting that is about to get underway in Europe. News about the dollar could have an impact on rates.


VOLATILITY LEVELS LOW





The volatility level for the 10-year note continues to drift lower and lower and is currently well below the average. For bond and note option premium sellers, this low level of volatility needs to be taken into consideration before selling short. Not only does low volatility translate to low option premiums, there is also the risk that a volatility spike could turn your far out-of-the-money options into in-the-money positions.

I will be watching for a bottom in the rates. At that time, you could consider a number of instruments to take advantage. For stock portfolios, consider the Short and Ultra Short Bond ProShares. These instruments will rise in price as interest rates rise. For well-capitalized players, consider entering into a short 30-year bond or 10-year note futures position to maximize your profit potential. For those who wish to make some money with less risk, consider selling out of the money bond and note call options.

Be sure to work with a futures investment professional to advise you on such strategies. Futures trading is very risky but when done right, can give you great profits in any kind of market.

OUR MARCH OPTIONS RESULTS

Despite the low level of volatility during March and the sharp move in price caused by the Fed’s announcement to buy long-dated treasuries, our futures options trading positions returned $915 per $10,000 investment net of transaction costs. I enter April short options with a bias to the upside for bonds. I will be watching for a reversal soon and expect bonds to fall by the end of the month.