From the Desk of Ian Culley @Ianculley

It’s been a lonely rise for interest rates.

The stocks and commodities that tend to accompany rising yields haven’t kept pace since early spring. Rates across the curve have accelerated higher, leaving these risk assets in the dust. 

But the seasons have changed – and the dust has settled. 

Cyclical value sectors have found their footing in recent months. Now, they’re playing catch-up.

One of the strongest market themes in recent weeks has been the reemergence of value over growth.

Check out the overlay chart of the 10-year US Treasury yield $TNX and small-cap value $IWN versus small-cap growth $IWO:

From the Desk of Ian Culley @Ianculley

Bonds are an absolute dumpster fire. 

Everyone knows fixed income is having one of its worst years on record. And, from the looks of it, we’ll all be dragging our Christmas trees to the curb before US Treasuries stage a miraculous comeback. 

Don’t get me wrong. I believe these safe haven assets will dig in and catch higher –  eventually. There’s just no sign of it happening any time soon.

Instead of focusing on the disappointing performance of bonds, let’s turn our attention to its relative trends against other major asset classes – stocks and commodities.

Here’s the commodities versus bonds ratio using the CRB Commodity Index and the 30-year Treasury bond futures:

From the Desk of Ian Culley @Ianculley

Bonds have stopped falling across the board!

That doesn’t mean it’s time to go all in. Tactically, it’s difficult to get behind this week’s near-term strength. 

Right now, we’re looking at just a few days of bullish price action. And where do we define our risk?

We have to know where we’re right and where we're wrong before we get involved in any investment. 

Thankfully, high-yield bonds answer this all-important question.

Check out the daily chart of the High-Yield Bond ETF $HYG:

Unlike most bonds, HYG has formed a small reversal formation.

From the Desk of Ian Culley @Ianculley

Don’t catch falling knives!

It sounds simple enough. But in reality, traders continue to lose fingers as they reach for downtrending assets.

Diving after downtrends isn’t one of my many afflictions. But I do have a theory…

Traders and investors don’t realize they're catching a falling knife in the moment. They believe they’re bargain-hunting.

So if you’re one of the many investors out there mending fresh wounds this week, I want to make one thing clear…

Bonds are a falling knife.

Check out the chart of the 30-year T-bond:

Do you really want to buy this chart?

Sure, the downtrend is stretched and ripe for some mean reversion. But as long as it’s below 127’23 we’re short with a target of 116. 

It’s the same story with $TLT:

From the Desk of Ian Culley @Ianculley

If you can pry your eyes from the UK gilt and Credit Suisse articles, you’ll find it’s not all doom and gloom across the bond market – especially high-yield debt in the US.

A quick warning before we continue: You probably won’t see a similar message on the financial news. It’s just too optimistic for the current environment. It wouldn't get enough clicks.

But facts are facts. And right now, high-yield bonds are hooking higher, while stocks are also rising.

Check out the dual-pane chart of the Fallen Angel High-Yield Bond ETF $ANGL and the S&P 500 $SPX: 

From the Desk of Ian Culley @Ianculley

Don’t let credit spreads fool you. 

High-yield debt hasn’t blown out relative to Treasuries. Regardless, the largest markets in the world are buckling under pressure.

You have to look outside the US and beyond high-yield corporate bonds to see the stress. Here are three cautionary data points to consider: European sovereign spreads, US bond market volatility, and the steep decline in investment-grade bonds.

When you weigh the evidence, it’s clear risks are rising for US markets. 

Let’s look at the charts!

First, here's a look at European sovereign spreads:

From the Desk of Ian Culley @Ianculley

On Wednesday afternoon, the Federal Reserve announced another 75-basis-point rate hike following its September policy meeting. 

Yields across the curve ripped, and Treasury bonds dipped.

What else is new?

An aggressive hiking regime has been the Fed’s modus operandi since March. And it's made clear its intent to stay the course.

But what does the rest of the market think about the rise in rates?

Let’s look at our intermarket ratios to gain some insight.

First, we have a triple-pane chart of regional banks versus REITs, the copper/gold ratio, and the US 10-year yield:

These key intermarket ratios tend to peak and trough with interest rates. Notice all three peaked in 2018.

From the Desk of Ian Culley @Ianculley

Interest rates have resumed their ascent following a brief summer pause. And, in recent weeks, their climb has accelerated.

Aside from lower bond prices, what do higher rates mean for other assets, such as stocks and commodities?

It might seem like a simple question. But its relevance is undeniable given the current market conditions.

We’ve been vocal about the cyclical areas of the market that benefit most from a rising rate environment – think commodities, energy, materials, and banks. We’ve put out plenty of trade ideas in those areas.

But not all risk assets enjoy a tailwind when yields rise.

Higher rates mean downside pressure for long-duration assets in general, not just bonds. This also includes growth stocks!

Check out the chart of the US Treasury Bond ETF $TLT overlaid with the growth-versus-value ratio:

From the Desk of Ian Culley @Ianculley

After Federal Reserve Chair Jerome Powell’s remarks this morning, the market is pricing in an 86% chance of a 75-basis-point hike later this month. 

Meanwhile, rates continue to accelerate at the short end of the curve. That’s been the story for months now. 

But will the middle and long end of the curve head higher as well?

According to the two-year US Treasury yield, the answer is a resounding "yes!"

Short-duration rates offer plenty of valuable, leading information regarding US Treasury yields.

We’ve leaned on the five-year yield throughout the current cycle as an early indication of the direction of the 10- and 30-year. It’s proved a beneficial practice.

Today, we’re going to drop it down a notch, extending the same logic to the two-year yield.

Here’s a quad-pane chart of the two-, five-, 10-, and 30-year US Treasury yields:

From the Desk of Ian Culley @Ianculley

Heading into Q3, we wanted to play a mean-reversion bounce in US treasury bonds. A long list of reasons supported this position:

• US Treasuries experienced their worst H1 in history (or close to it).
• Bonds were finding support at their previous-cycle lows from 2018.
• Commodities and inflation expectations peaked earlier in the spring.
• Assets that benefit from rising rates (financials) were making fresh lows.
• Global yields were pulling back.

And, quite frankly, our risk was well-defined. We can’t ask for much more. For us, the greater risk was not taking a swing at this trade in the event bonds ripped higher…

Two months later, bonds across the curve are taking out their 2018 lows. The market has proven our mean-reversion thesis wrong. But we can live that because we manage risk responsibly.

It’s the most important part of playing this game.

Easily, the second-most important is to remain flexible.

From the Desk of Ian Culley @Ianculley

Identifying trends is one of the most important jobs of a market technician. Regardless of our time horizon, we have to understand the general direction the market is taking.

It sounds simple, but it’s the foundation of any market thesis.

Once we have the underlying trend nailed down, we can focus on the areas of the market we want to exploit and pinpoint the best tools and strategies to do so.

When I think of the most critical trends to date, my mind immediately goes to interest rates. Rising rates and inflation have been the key drivers for two years now.

Despite some corrective action in recent months, the bond market has been reminding us that we’re still in a rising-rate environment.

Let’s take a look.

First, we have an overlay chart of the US 10-year breakeven inflation rate and the US 10-year yield: