Forget Stocks, Discover Where The Real Action Is
So far, it’s been another harsh day for stocks. As of this writing, the Dow Industrials are down another 230 points (-1.6%) while the S&P 500 is down nearly 30 points (-1.9%).
The selloff is a continuation of the “correction” the markets are experiencing after Bernanke’s comments last week regarding the slowing/stopping of the Fed’s controversial bond buying program.
As I’ve said before, I don’t believe any major pullback in this market will be long-term in nature. The only reason the Fed will cut its stimulus program is if the economy is doing well enough to justify it.
And if the economy is doing better, then we don’t need the additional stimulus.
But, investors are fickle. And, we’ll have to see just how long it takes for the markets to stabilize.
Here’s the thing…
The stock pullback just isn’t that big of a deal. Yes, the Dow has dropped 700 points since mid last week. However, that’s not even a 5% drop in the widely-followed benchmark.
On the other hand, the bond market is where the real action has been.
The yield on the 10-Year Treasury Note is up another 4% to 2.6% today. Now, that may not seem like a lot. But keep in mind, in early May, the yield was just over 1.6%.
That means the 10-Year yield has risen 1% in roughly six weeks. That’s a 63% spike in the country’s most important interest rate benchmark!
The ramifications of this bond move are huge. Most importantly, it’s affecting mortgage rates. The average 30-year loan is already up to nearly 4.5%. That kind of jump could significantly deter home buying and refinancing activity – clearly a bad thing for our slowly recovering economy.
You see, the bond market will always front run the Fed. Today’s interest rate is a reflection of what interest rates will be down the line. After all, we are talking about a TEN year bond or a THIRTY year mortgage. The future needs to be accounted for as well.
This front-running nature of the bond market is why I believe it was a mistake for Bernanke to talk about tapering the bond buying program. Yes, the economy should be better. And, he doesn’t want to create an asset bubble.
But, isn’t it self-defeating to see interest rates spike while the economy isn’t at full steam?
At this point, only time will tell. However, there are several ways to use options to trade this complex situation. If you believe homebuilders are going to continue to feel the brunt of the interest rate increase, you could buy puts on a homebuilder ETF or the companies themselves.
Or, you could trade the bonds themselves by utilizing options on Treasury-related ETFs. If you think interest rates are going to react severely on upcoming Fed announcements, one thing to consider is buying straddles or strangles. This strategy will make money on a big interest rate move in either direction.
Bottom line, there could be a lot of volatility in the markets over the next few weeks or months. But, if you really want to follow where the action is, keep an eye on the bond markets.
Yours in Profit,
Gordon Lewis
Category: Breaking News
