Last week I posted what Cullen Roche of Pragmatic Capitalism thought was the major risk for 2014. In today’s post I want to list one of the two major risks (excluding any exogenous shock) I see to the investment markets for this year. Because all markets are interlinked and the bond market is so big, it’s easy to think of bonds as the dog and stocks as the dog’s tail. As such, anyone holding equity investments needs to keep a very close eye on the bond market.
Below is a 20 year view of the 30-year US Treasury bond. As you can see it has been in a very well defined upward (bull market) channel. Like all investments it moves up and down but during this entire period it has respected its channel boundaries. In the highlighted areas I have noted major price swings down (corrections) and the time it took to complete each.
An interesting aside is that an astute investor could have purchased the long bond as it neared the bottom of the channel and sold as it approached the top and been handsomely rewarded over the past 20 years with very low risk investment strategy that would have outperformed just buying and holding.
The chart below is the exact same chart as the one above except I am only showing the last 5 years’ worth of data rather than 20. As you can seek the current correction we are in has been going on for well over a year now and if history holds, either has already or is close to completion as it nears the bottom of the channel. While I continue to stress no one can predict the future, the chart is telling me the decline is very close to being done as positive divergence has formed on our momentum indicators. This is a heads up that momentum has changed course (up) and price should be not too far behind. While timing is never exact, if we were to fall further one could imagine a decline to the exact bottom of the channel, which is less than 3% away from where we are.
So you are probably wondering what and how this all ties back to the topic of this post, risk to the markets. At some point the FED will either loosen their reign on interest rates (think taper) or the market will demand higher rates. If rates rise and go high enough, history says stocks will suffer. The reason for that is if investors have a much lower risk alternative providing a similar return, they tend to take the path of lowest risk. If this happens, the nice, well-formed and respected price channel of the past will be breached to the downside.
Nothing lasts forever, so for now and until price tells us otherwise, the channel is still in control but watch out if/when it is violated.