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What Do Treasury Valuations Mean for Risk-Off Positioning?
There is still rampant uncertainty within the market. The “Fedication” doled out by Chair Powell wasn’t the cure the market was looking for.
Investors will likely remain positioned for a risk-off market until the dust fully settles.
However, Treasuries are trading well below average yields so investors looking for a risk-off exposure that does have a bit more juice could consider an actively managed ultra-short duration strategy.
The sizeable equity market selloff over the last two weeks has led to a flight to safety, pushing US Treasury 10-year yields to all-time record lows and below 1% for the first time ever. For investors with a diversified asset allocation this has been a benefit to portfolios, as while US stocks are down 7% year-to-date Treasuries are up 6%1.
But with yields at 1%, how much juice is left2?
The drop in yields has pushed bond valuations to equally extreme levels. Some may want to quote the US 10-year yield versus its long-term historical average (6.08%) and proclaim that it is 85% below that level, and therefore really rich! However, that is misleading as we have been in a much different market the last 10, 5, or even 3 years. It would be like comparing Reggie Miller’s three-point shooting to James Harden’s – two great shooters, but Harden is playing in the era of taking as many threes as possible. Not a fair comparison.
A better gauge of valuations is to evaluate the US 10-year yield versus its 36-month exponential moving average (eMVA). I won’t go into the statistical properties of the eMVA, much like how I usually gloss over the statistical backing related to taking as many three-pointers as you can when talking hoops with traditionalists, but it basically places a greater weight and significance on the most recent data points. An exponentially weighted moving average, therefore, reacts more significantly to recent price changes than a simple moving average (SMA), which applies an equal weight to all observations in the period.
As of right now, as shown below, the US 10-year yield is 56% below its 36-month exponential weighted moving average. This marks the largest discount to a 36-month eMVA ever. More than during the dot-com bubble, financial crisis, 2011 US sovereign downgrade, and more recent risk-off moves in 2016 and 2018.
Source: Bloomberg Finance L.P. as of 03/04/2020
Now, it has traded below its 36-month eMVA since May 2019 and Treasuries have returned 8.3% since then. So, just because it’s below the 36-month eMVA, doesn’t mean valuations are restrictive on future returns. However, as illustrated in the chart, these levels are at extremes and in prior cases, they have tended to mean revert.
There are three takeaways:
- Along with other technical indicators (VIX cure, % of stocks below 50-day moving average), the current steep discount for the US 10-year versus its 36-month eMVA is another example of how risk-off and anomalous this latest microburst of volatility has been
- There is not much juice left, however. It would take a 40 basis point drop to replicate the returns over the last week (+2.7%) and that would push the rate to 0.54%
- That doesn’t mean this very low rate era cannot continue. In prior deep discounts, it took an average of 11 months before the US 10-year mean reverted and broke above the 36-month eMVA
Overall, there is still rampant uncertainty within the market. The “Fedication” doled out by Chair Powell wasn’t the cure the market was looking for to remedy the virus-led volatility, and investors will likely remain positioned for a risk-off market until the dust settles.
However, investors looking for a risk-off exposure that does have a bit more juice, could consider an actively managed ultra-short duration strategy like the SPDR SSGA Ultra Short Term Bond ETF (ULST) that can venture into different sectors and segments.
1Bloomberg Finance L.P. as of 03/04/2020
2Bloomberg Finance L.P. as of 03/04/2020 based on US 10 Year Yields
eMVA
An exponential moving average is a type of moving average (MA) that places a greater weight and significance on the most recent data points.
SMA
Simple moving average is the simple average of a security over a defined number of time periods.
The views expressed in this material are the views of Matthew Bartolini through the period ended March 4th, 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investing involves risk including the risk of loss of principal. Past performance is no guarantee of future results.
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