Big Moves for a Forgotten & Unloved Asset Class

December 9, 2022  |  Michael Reilly

Have individual investors forgotten there is more than one asset class?

It sure feels that way, because lately, all the excitement seems to be about one asset class – stocks.

I get it, stocks have had an incredible rally coming off their October 2022 lows. But I’m not focusing on stocks today.

There’s another asset class that dwarfs the size of the equity market. And although you’re not hearing much about it, you should be.

This Asset class is historically the first to move higher off the bottom, marking the beginning of a new cycle.

I’m talking about boring old Bonds.

Now, I know what you’re thinking…

“I’m not a bond buyer.”

Well, you might want to reconsider.

Let me set the stage here…

The graph below illustrates the classic business cycle and includes the rise and fall of stocks, bonds, and commodities (intermarket relationships) during a normal inflationary environment.

Stages 1, 2, and 3 are part of an economic contraction (weakening, bottoming, and strengthening). In the first stage (highlighted) the economy is continuing to contract. But, bond prices begin reversing higher as interest rates decline.

This is the early stage for the next expansion of growth in the economic cycle.

We all know, interest rates are not yet moving lower. On the contrary, the Fed still plans to continue raising rates, likely with a reduced rate of increase (.50% vs. .75%).

Both Stocks and Bonds are rejoicing in the belief that maybe the Fed is closer to the end of this cycle of raising rates.

What happens next is the economic weakness (caused in part by higher rates) leads the Fed to reverse course and loosen its tight monetary policy and begin lowering interest rates, which is bullish for Bonds.

That’s the back story. Now let’s talk price…

I’m not making a timing call here, I’m merely reminding you not to overlook the Bond market and the opportunity it presents early in the development of a new cycle.

I’m only interested in looking at the price charts of various asset classes and sectors and trying to answer the age-old question…

Are these securities we’re interested in buying?

To that end, I want to spend a few minutes sharing some interesting developments in the Bond market.

It’s been a long time since we’ve been able to say anything positive about Bonds. They’ve spent the better part of two years getting crushed. But that looks like it may be finally changing!

Take a look at this ratio chart comparing the strength of Bonds vs. Stocks. Specifically, I’m comparing the S&P 500 (SPY) to the 20-year Treasury Bond ETF (TLT) on a relative basis.

I’ve inverted the chart to better illustrate the recent strength out of Treasuries over Stocks. As the blue line descends, the math says Bond prices are weak relative to stock prices.

And that’s what we saw following the spike in Bond prices in April 2020. From that point onward, Bonds have remained weak relative to stocks.

That weakness continued throughout the remainder of 2020, all of 2021, and most of 2022, finally reversing in November of 2022 (circled in red).

And that’s when it gets more interesting – almost exciting!

Bonds found at least a short-term bottom in October/November 2022 and that’s when Bonds (specifically, 20-Year Treasuries) began to push higher relative to SPY.

We could see that in the Relative Strength chart as the line reversed higher, indicating Bond prices are stronger than stock prices.

And we can see it in absolute terms via a price chart of the 20-Year Treasury ETF (TLT).

Treasury Bonds (TLT) have found support at the 2011 lows – reversing higher off those lows. And for anyone who thinks only equities can offer double-digit returns, you’re wrong.

TLT has gained almost 20% off the recent lows. Stodgy old Treasury Bonds are up 20%!

Not bad, huh? You have to admit, that’s an impressive move for what has become a forgotten and unloved asset class.

Don’t ignore Bonds. You may be missing an opportunity that doesn’t come often in this segment of the market.

We don’t know for sure if this is the bottom for Bonds, or if this is just a short-term bottom prior to another leg lower.

That’s why we’ll continue to analyze the charts. We know historically what the business cycle is and where to look for profitable opportunities as the cycle evolves.

This is a matter of when – not if.

So, stay tuned for further updates about this beaten-down asset class and if you’d like to see how we can help you adapt to the markets in real-time like we do here at Avalon, schedule a free 1-hour consultation with us now.

Until next time, invest wisely.

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