The most important development in the last month may be one that hardly anyone is discussing: interest rates.
Both the U.S. ten year note and long bond have seen tremendous drops in yield since early April. In the case of the benchmark ten year note, dropped from 4% to 3.1%. before rebounding at the end of last week to roughly 3.3%. That’s an astoundingly bullish move for such a short time frame and one that demands further investigation. First, though, have a look at the chart of the ten year note yield, and remember, bond yields move inversely with price:
A cursory reading of the ten year note chart reveals the following;
• First, the current price action is range bound, vacillating between 3.1% and 4% for the last year (two blue lines on chart). A breakout from this range would likely engender a significant move in the direction of the breakout and offer a nice trading opportunity.
• Second, MACD readings are tipping us off to a potential further drop in yields – or higher prices in the offing.
• Third, the trend in the ten year pits continues to be toward lower yields and higher prices. This is as it has been, generally speaking, since Paul Volker ratcheted rates higher in the early 1980’s. That’s an important point, and one many forget. Bonds have been in a secular bull for roughly 30 years. And the latest extreme action taken by the Federal Reserve and Treasury have done nothing to crimp that bull.
Of course, this will all eventually come to an end; though when, exactly, we can’t say. Rates have been rising and falling for months at a stretch over the last three decades, but always within the context of the larger, secular bullish trend. Whether we are entering a new phase in the world of fixed income investments – a rising rate phase – will only come clear sometime before the end of next year (2011) – a relatively short duration in the world of bond investing.
In the meantime, it’s not fundamentals but flight-to-quality concerns that are driving bond buyers to the relatively miniscule yields available on U.S. sovereign debt. And that’s not a good sign for the secular bond bull. Global growth rates are calling for continued easy monetary policies, yes, but if and when crisis conditions are relieved, investors will quickly sniff out better – and safer – places to park their money.
Until then, crisis conditions are good for treasuries. And that’s where the story gets interesting.
The Buck Stops Here, In America – Love Her or Go Broke
When the world gets scared, she runs to Uncle Sam. And that’s the simple reason why every major market is off in 2010 (with a few exceptions) more than the American market. Take a look at the chart below.
Clearly, U.S. assets are prized over the rest of the world’s. The exceptions, Mexico and Canada (sorry to say) are basically digits on the invisible (American) market hand.
Which is all to say that we are likely to see better relative growth in either U.S. stocks or bonds going forward than from any other nation or market. The decisive factor determining whether equities or debt outperforms will be whether we continue in crisis mode or obtain some relief from current fears of a potential European default. Stated in mathematical terms, it might look like this:
FEAR = BOND BULL RELIEF = EQUITY BULL
If we had to bet, we’d guess European fears will soon prove overdone, treasury yields will rise, the Euro will rally and stocks will drift higher.
Sidestepping the Dog
Until then, we’re being cautious. We’re looking at high yielding, well managed companies with predictable cash flows because they tend to behave like both bonds and stocks at the same time.
There are a number of sectors that boast such issues. The utilities, for instance, have long been prized for their suitability in the ‘orphans and widows’ portfolio.
But lately several other sectors have been acting like utilities, insofar as they’re regulated, throw off regular wads of cash and are operated by conservative management teams that reward shareholders for owning their shares. Telecoms and a great number of health care issues are the new joiners to the club. And that’s where we’ll find this week’s opportunities.
Get dull, friends. This is no time for an adventure.
Our fellow Oakshire analyst, Matt McAbby, pointed out last week that those were the sectors that both fell the least during the market’s recent decline and rose the least since the lows were set on May 25th. Here’s the way it pans out graphically:
The bottom four market sectors clearly had the mildest reaction to the latest broad market moves.
We’re looking very closely now at the telecoms, with an eye on ADRs that possess great fundamentals, hailing specifically from the most troubled European nations – the so-called PIIGS group, Portugal, Italy, Ireland, Greece and Spain. And as it turns out, there is one issue that stands out from the crowd.
It’s a stock that boasts solid fundamentals, has a steady cash flow, pays a very respectable dividend and is now grossly out of favour. Here’s two years’ worth of daily chart for Telecom Italia (NYSE:TI):
The way we see it, Telecom Italia is a perfect play on an oversold Euro, a battered Milan bourse and our own general need for cash and income. The downside looks all but in on this one.
TI pays 5.75% annually, trades with a multiple of 6.91x last year’s earnings and has been pushed lower by bad European news and a weak Euro.
The company sells today for less than 70% of its breakup value and at just 0.67x sales. Those are outright bargain numbers.
Technically, TI’s shares appear to have stretched too far below the long term moving averages too quickly. They’ve also bounced off long term support at the trendline. We see a snap move up to roughly $14.50 from the current $11.83 – a gain of 23%, and we’re buying.
Wall Street Elite recommends purchase of Telecom Italia (NYSE:TI) shares below $12.50 with a stop loss placed at $.11.00
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