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The Bernanke Treasury Bond Market Put

Interest-Rates / US Bonds Oct 03, 2010 - 04:42 AM GMT

By: Peter_Navarro


Best Financial Markets Analysis ArticleAccording to Market Edge: “After four weeks of impressive gains, stocks took a breather last week as both the DJIA and the NASDAQ ended the period with minor losses. The DJIA started the week with a 48.22 point (-0.4%) loss which was just the fifth losing session in September. Traders bought the dips throughout the week as the DJIA saw triple digit intra-day swings on both Tuesday and Thursday. Despite several disappointing economic reports, traders kept a bullish outlook throughout the week. For the period, the Dow lost 30 points (-0.3%) to close at 10829, snapping its four week win streak.&r

This is indeed either a breather or the knocking of the markets on a glass ceiling otherwise known as a sideways pattern. You know my concerns. While September was as pleasurable as August was painful, there are still some major tests of technical resistance ahead before we can feel comfortable with the idea of an uptrend.

As always, we must look to economic fundamentals to handicap the markets next technical moves. This last week we had a minor drop in the ISM manufacturing index and the leveling off of the ECR I Weekly Leading Index. Meanwhile, consumer sentiment offered a similarly uncertain picture. Based on what we continue to see from the economic data, this is a "watch and wait" period in which short-term traders can try to take advantage of the upward trend an buy-and-hold investors should remain mostly in cash on the sidelines.

With that out of the way, let’s talk about some longer-term business. In the last newsletter, I trumpeted some of my recent calls in the biotech space – PBTH, CHTP, and SVNT were all double- or triple-digit winners. I also trumpeted two of my short calls on Palm and RIMM and a long on Apple at $250 – likewise huge double-digit winners.

Just to make sure that I don't get too full of myself, several readers absolutely hammered me for my short call on gold in mid July and my call to short the long bond in mid April. I think it is worth talking about each of these trades because discussing the gold trade will help remind readers about the importance of managing your trades and taking profits while discussing the bond trade will both underscore the need to cut losses early and to understand from a macro point of view what drives bond prices and yields.

Let's start with my “short the gold market” trade.  On July 15 when I made the call, the exchange traded fund GLL which shorts the gold market as an unleveraged ETF, was priced at $39.78. By July 29, it hit a high of $42.73 – a nice little gain.

At this point, a seasoned trader would've put up stop loss at at least the initial buying price, and such a stop loss would have been triggered as early as August 6 – no harm, no foul.   My point is simply that any stock that you buy whether because of your own research or by reviewing the research of others requires careful money management and risk assessment. If you don't know how to use stop losses and trailing stops and set your stop losses near key levels of support, then you really have no business engaging in short-term trading at all.

So my advice if you are losing money on trades that first went up but then went back down is to do some more research on trading techniques.  In this regard, I can say without too much self-promotion that my book When the Market Moves, Will You Be Ready? Is a pretty good manual on how to trade and manage both your risk and cash..

Now let’s turn to my “short the long bond” trade – arguably my biggest loser in the last several years.  My instrument of choice is an ETF called TBT. Let's break this one down.

I first flagged this one around April Fools' Day when the price was just around $50. Unfortunately I wasn't joking about buying this dog because as of now it's down to almost $30. Of course, anybody who rode this from $50 down to $30 really needs to go back to Trade School. The most you should ever lose on a trade is 10%,  In fact, if you manage your money well, you can still make a lot of money even if six out of every 10 stocks you pick are losers.

My logic for shorting the long bond in April was simply this: the economy looked like it was recovering, federal budget deficits were spiraling out of control, and these two factors should have pushed the long bond yield up and prices down. What I didn't bargain for was the financial crisis in Europe that made the dollar a safe haven for global investors – and when I say the dollar, what I mean is that these investors bought a ton of US government bonds after exchanging euros for dollars. This had the effect of both driving the dollar up and bond prices up.

This is hardly the end of the story, however. The TBT trade has continued to grow worse as the economy has softened and Federal Reserve Chairman Ben Bernanke has pledged to engage in so-called quantitative easing to further stimulate the economy.

Quantitative easing is a way for the Federal Reserve to manipulate long bond yields by purchasing US government bonds which are being issued to finance the US government budget deficit. The net result of quantitative easing is to provide long bond holders with a hedge against the risk of falling bond prices. In this way, the Bernanke policy of quantitative easing represents a “Bernanke Put” by providing bondholders with put protection on bond prices just as from the late 90s to the early 2000, Fed chairman Alan Greenspan used a policy of easy money to provide stock market investors with put protection of falling stock prices.

While I know this is going to sound like the stupidity of the 1990s tech bubble, I will now say with no tongue in my cheek that if you liked TBT at $50, you will love it at $30. Yep, I haven't given up on this trade-- although I feel a little bit like the guy in the movie Tin Cup who kept trying to hit the ball over the water.

My reasoning is that at some point bond prices are going to have to plummet and yields are going to have to skyrocket as an era of cheap money, huge deficits (and a possible rising Chinese yuan) put a bloody end to the bond market bubble and the Bernanke Bond Put.

So I have begun to rebuild a small position in TBT and I continue to add a little bit to it every time it drops another point. Call me crazy, but I have no doubt that this trade will eventually pay off big. It's simply a matter of time, and the difference between doubling down on an exchange traded fund like TBT and an actual stock of a company that is performing as badly as TBT is this: the company likely sucks and that is what explains its poor stock performance. In contrast, with TBT, it's only as good or bad as it's macro environment –there are no dumb managers or bad products or anything else to worry about. Because I just don't think interest rates will stay at record lows forever, I going to keep a hand in the TBT game just like I kept trying prematurely to short housing stocks during the housing bubble and kept getting burned – and then one day I didn't.

So that's my TBT story and I'm sticking to it. I'm bleeding a little bit with it, but my biotechs and other trade have more than offset any small losses in TBT. Eventually I think TBT will be a good trade. At any rate, a position in TBT helps keep me in tune with the economy as I have plenty of skin in the game to pay attention.

As a final note, there are often typos in this newsletter and the culprit has to do with the fact that much of it is dictated using Dragon Naturally Speaking. The accuracy rate is quite high, but some silly things do slip through. So if you see something that doesn't look quite right, trust the syntax and make your own internal correction.

Navarro on

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Professor Navarro’s articles have appeared in a wide range of publications, from Business Week, the Los Angeles Times, New York Times and Wall Street Journal to the Harvard Business Review, the MIT Sloan Management Review, and the Journal of Business. His free weekly newsletter is published at

© 2010 Copyright Peter Navarro - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


J Carlson
05 Oct 10, 09:06
Bernenke put

This lucid commentary on TBT & shorting T bills helped me very much: my investment advisor did just such a trade, now down 17% and sick to my stomach but have decided to ride it date, anyways.

Thank you 4 the insights!!!

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