The stock market, or all financial markets, has changed significantly over the past couple of decades. The main change is that the concept of individualism, in which assets behave separately and individually from each other, has disappeared. Today, all markets are interconnected in a way that investors need to pay attention if they want to have a chance at success.
This means that if asset classes such as gold or currencies begin to move and their correlation changes from positive to negative or vice versa, investors need to know what is causing this correlation so they can play accordingly and profit from the movements. .
iShares 20+ Year Treasury Bond ETF Today
iShares 20+ Year Treasury Bond ETF
(As of 12/24/2024 5:19 PM ET)
- 52 week range
- $86.98
▼
US$101.64
- Dividend yield
- 4.27%
- Assets under management
- $57.05 billion
For this reason, today’s changing market is important to benefit from the potential of long bond trading.
More specifically, there are three main reasons why investors should pay attention to iShares 20+ Year Treasury Bond ETF NASDAQ: TLT for the coming months and quarters, especially as price action in other inflation- and interest rate-sensitive asset classes shows them how the future could look brighter for bond prices.
With that in mind, here’s the first reason why investors might consider this bond exchange-traded fund (ETF) for their portfolio.
Slowing Inflation Requires Bond Adjustment
The way the iShares 20+ Year Treasury Bond ETF has traded over the past few months is not entirely related to the current business environment. While the behavior of some asset classes and stocks, such as consumer discretionary stocks, may signal inflation, concerns about rising prices and costs are simply not there today.
The recent inflation numbers that the Federal Reserve (Fed) is looking at, as well as the PCE and PPI indexes, are the opposite of what these stocks are calling for. This is why the price of gold just fell sharply, along with other inflation-sensitive assets like crude oil and their corresponding pullbacks.
Why should inflation-driven commodities fall from their highs if inflation is driving the bond sell-off? Since this doesn’t make much sense, this will lay the groundwork for the three reasons behind the bullish thesis for a potential long position in this bond ETF.
Adjusting bond prices based on actual inflation will allow investors to take advantage of the risk-reward structure of this ETF. The disadvantage (i.e. higher rates) is minimal compared to how high prices (and resulting lower rates) can be.
iShares 20+ Year Treasury Bond ETF (TLT) price chart for Wednesday, December 25, 2024.
Small cap stocks converge with bonds, next divergence?
Correlations among small cap stocks as seen in iShares Russell 2000 ETF NYSEARCA: IWM and iShares 20+ Year Treasury Bond ETF rose to cyclical highs. This means their price movements have now converged, as the two asset classes have declined significantly over the past few weeks.
What naturally follows from this convergence is a breakdown in correlation, reflected in the divergence between small-cap stock prices and bond prices. Essentially, as stated in the previous point, a bond rally is much more likely than a selloff, making this divergence the likely situation that would benefit bonds the most.
This also makes fundamental sense because small-cap stocks (consisting of smaller domestic businesses) cannot diversify costs or cycles as effectively as large-cap stocks can. Slower inflation and business activity will likely push small-cap exposure lower, while rising bonds will push yields lower.
Then, as correlations return to cyclical lows and yields fall, reflecting easing inflation and Fed cuts, the environment will be much more favorable to allow small-cap stocks to rally again and converge with bonds.
Energy stocks expected to boom, are bonds bullish?
Warren Buffett became a leader in the energy sector when he recently bought up to 29% of the shares Occidental Petroleum Co. New York Stock Exchange: OXYbecause he knows what a fall in bonds may lead to in the future. As slowing business inflation impacts small caps, it also impacts oil demand and prices.
However, once rate cuts spread to the rest of the economy, a bond rally and lower yields could not only help small-cap companies, but also boost overall business activity in the broader market. That’s when oil demand could come back on the scene, pushing up prices per barrel and associated inventories.
Correlation between bonds and Select Energy Sector SPDR Fund NEW SIRKA: XLE show this theme in the game. Convergence doesn’t make much sense since these assets tend to be negatively correlated. The natural deviation from here will favor a bond rally before the oil rally arrives, giving investors a third way to justify buying an ETF.
Before you consider the iShares 20+ Year Treasury Bond ETF, you might want to hear this.
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