EC T-Notes On A Tear

Just when everybody thought the bull was dying, it suddenly revived. And in a big way.

The bull? The bull market in bonds and notes, I mean. You may remember the chart below. It last appeared in an April column highlighting a developing market turning point. The graph depicts, on a logarithmic scale, the ratio of the S&P 500 Index (SPX) over the CBOE 10-Year Treasury Note Yield Index (TNX). The beauty of the chart is in its distillation of secular market trends which, for the past four decades have been decidedly bullish.

Late last year, though, fear prevailed and threatened the uptrend. From the looks of the last few data points, you’d think that fear has dissipated. And, with the closing of the books in May, you’d be half right. Stocks are still looking wobbly, but T-notes are on a tear. 

(Click on image to enlarge)

T notes ETFS

The S&P 500 lost 6.6 percent in May while the 10-year note wrapped up the month with a yield of 2.14 percent, 37 basis points lower than April’s finish. You’d think holders of exchange-traded funds tied to 10-year paper would be cheered by this.

Again, you’d be right. But some ETF investors are happier than others. A LOT happier. Those most pleased hold the iShares 7-10 Year Treasury Bond ETF (NYSE Arca: IEFwhich appreciated 2.8 percent in May.

Owners of three other intermediate-term Treasury ETFs had to content themselves with a gain nearly a full percentage point lower. Why? It’s all in the index tracking. IEF attempts to replicate the returns of the ICE U.S. Treasury 7-10 Year Bond Index, while the other portfolios are now benchmarked to the Bloomberg Barclays U.S. 3-10 Year Treasury Bond Index.

You can probably see where this is going. The $14.3 billion IEF portfolio, which is larger than all three of its competitors combined, is biased toward longer maturities and durations. That translates to higher interest rate sensitivity and volatility. The fund is populated by notes with an average maturity of 8.3 years, giving it an effective duration of 7.4 years.

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Disclosure: None.

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