This Top Pick recommendation is betting on interest rates rising.
Direxion Daily 20 Plus Year Bear 3 Shares (TMV), Proshares Ultrashort Lehman 20 Plus Year Treasury (TBT), Proshares Short 20 Plus Year Treasury (TBF)
from Sound Advice
No-Brainer ETFs are designed to benefit from the inevitable rise in long-term Treasury bond yields. They differ in the amount of leverage used: The Direxion Daily 20 Plus Year Bear 3 Shares (TMV) uses 3:1 leverage. The Proshares Ultrashort Lehman 20 Plus Year Treasury (TBT) uses 2:1 leverage. The Proshares Short 20 Plus Year Treasury (TBF) uses no leverage.
You can choose one or all of these ETFs, depending on your investment objectives and risk tolerance. We have dubbed these ETFs as “No-Brainers” because interest rates always rise after a recession during the recovery. The upward path has never been smooth, and this time is proving to be no exception.
The Fed is now officially done with its massive quantitative easing (QE) Treasury bond-buying program, clearing the way for the normal forces of supply and demand to take over. With Treasury bond yields at historic lows, they can only go up from here.
The Federal Reserve’s official forecast projects the benchmark Federal Funds rate will increase from zero currently to 1.2% by the end of 2015 and to 2.5% by the end of 2016. Beyond that, officials project that the Federal Funds rate could settle in at 3.75%.
At the very least, Treasury bond yields should move in tandem with the Federal Funds rate. That means long-term Treasury bond yields will rise from 3.07% today to 4.27% by the end of 2015, and to 5.57% by the end of 2016.
We can construct a model of these ETFs based on the Federal Reserve’s forecast. The price action of these ETFs is based on the changes in long-term treasury bonds, specifically BlackRock’s iShares 20+ Year Treasury Bond ETF (TLT) which holds a portfolio exclusively of long-term Treasury bonds with an average maturity length of close to 27 years. The prices of our No-Brainer ETFs fluctuate in accordance with the daily fluctuations of TLT, only in the opposite direction, multiplied by the leverage each uses. For example, a decline of say, 1.0% in TLT will cause TMV to increase by 3.0%, TBT by 2.0%, and TBF by 1.0%. Conversely, an increase in TLT will cause these ETFs to drop in the same fashion.
If we assume that the ascent in interest rates will not begin until the end of January in accordance with the Federal Reserve’s forecast, we may see these ETFs erode until then. There is an erosion factor with these ETFs because they decline slightly more on downswings than they rise on equivalent upswings in bond yields, and the erosion factor is more pronounced with leverage.
While these ETFs are no-brainers after a recession because interest rates always rise, the ride has been rougher than we first anticipated. However, even though the Federal Reserve’s forecast calls for a gentle increase over a long period, it would still push up the prices of these ETFs substantially, and demonstrates the profit potential. Whether the rise is gentle or steep, we are bound to see substantial profits in these ETFs.
Gray Cardiff, Sound Advice, 800-825-7007, December 3, 2014