Today’s Top Picks for 2013 mid-year update comes from Sound Advice Editor Gray Cardiff.
“Bond prices dropped sharply in mid-June, sending yields upward, just after Mr. Bernanke said that the Federal Reserve may begin scaling back its $85 billion monthly bond purchases later this year as long as the economy continues to improve. What seemed like an obvious statement turned into a bombshell.
“At the time of our May 1, 2013, issue titled ‘No-Brainer Buying Opportunity,’ the yield on 10-year Treasury bonds was 1.61%. The Bernanke reaction sent that yield to 2.67%. The yield on 30-year Treasury bond jumped over 3.6% from just under 2.86% on May 1, [which] jump-started our No-Brainer ETFs. The most responsive ETF, Direxion Daily 20 Plus Year Bear 3x Shares (TMV) which uses 3:1 leverage, climbed from $49.16 on May 1 to $69.70, or 41%. ...
“Bernanke’s statement is the best possible news for our No-Brainer ETFs. Although the economy was clearly recovering, and bond yields had already begun to rise, the Fed is promising to continue stimulating the economy until the recovery is firmly entrenched. By the Fed’s definition, that means until the unemployment rate is around 7%. This means the rise in bond yields is not over. More likely, it is just getting started.
“Keep in mind that the recent rise in bond yields occurred while the Federal Reserve is continuing its massive bond-buying program. The Treasury bond market is far greater than the Fed’s coffers.
“The June jump in bond yields caused speculation that the Fed may have lost control. ... The jump-start in our No-Brainer ETFs since May 1 gives us a glimpse of the profit potential they have. We have refreshed our hypothetical models.
“The most recent time long-term Treasury bond yields rose significantly was from December 18, 2008 to June 10, 2009, (118 trading days) when 30-year Treasury bond yields rose from 2.55% to 4.75%, or 220 basis points. Our No-Brainer ETFs did not exist during this entire period, so we don’t have historical track records to view, but we know how they work, and can model them to get an idea of the profit potential.
“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 (symbol TLT) which holds a portfolio exclusively of long-term Treasury bonds with an average maturity length of 27.54 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%. ... To construct our models, we start with a projection of an increase in 30-year Treasury bond yield. We begin with today’s yield of 3.50%, and project a 220 basis point rise using the same pattern that occurred from December 18, 2008 to June 10, 2009, which would bring the 30-year Treasury bond yield to 5.70. [In this scenario,] TMV (3:1 leverage) would climb from $64.72 to $160, for a 147% gain.
“[TMV is] not for an indefinite ‘buy and hold’ investment strategy. Excess volatility in bond yields over an extended period will cause erosion in the prices of these ETFs. More importantly, they will drop when bond yields decline, and are only for periods when bond yields are certain to rise substantially. However, these ETFs are worth a substantial investment right now for the immediate future because the profit potential is so great.”
Gray Cardiff, Sound Advice, www.soundadvice-newsletter.com, 800-825-7007, July 2013