The Greed is Back in the Market!
What is going on in the bond market? And is it finally time to buy Boeing?
Hello Pulsers,
Welcome back to another issue of the Market Pulse. This week, we will examine the recent market moves and what is happening in the bond markets. Before starting, I want to thank everyone for subscribing to this free weekly newsletter. If you have enjoyed this newsletter so far, share it with a close friend or someone interested in learning more about the markets.
On Markets
Another week and another all-time high in the markets. If you recall, two weeks ago, I mentioned that there is no such thing as triple tops in the market. As expected, the S&P500 did breakout and is now heading toward the 6,000 mark. The question is now whether this is a false breakout or a new bull run into 2025.
The S&P500 is trading closer to 22 times forward earnings, which, according to historical trends, is an expensive multiple.
I used this chart last week, which shows that the S&P500 is now trading in the 90th percentile, more expensive than any market in the world.
Investors continue to purchase the index, ignoring how expensive the market is. Now, according to CNN Money, we are in the “extreme greed” market.
In next week's newsletter, I will show you how to hedge your portfolio using proper tail risk hedging techniques. Share this newsletter with your friends, who might also find this valuable.
What is going on in the bond market?
I believe we are in the new rate regime. While at some point last year, we had 5% yields to maturity on the 10-year, I do not believe we will see the 10-year closer to 5% anymore. I believe the 10-year will trade in a narrow range shown below, between 4.3% at the top of the range and 3.8% at the bottom end of the range.
This range trading makes it an ideal scenario for selling puts on TLT 0.00%↑ or buying options on treasuries. I will discuss this in more detail later on.
But the question arises: If the Fed is cutting rates on the short end, why are the rates rising on the long end of the curve?
To answer this question, you must realize what impacts the long end of the curve pricing. Three key metrics control the long end of the curve:
Growth expectation
Inflation expectation
Term premium
The first two items are relatively straightforward. Growth expectation refers to the economy’s natural state at which it can grow without labour shortage and inflation. For the U.S., this number is closer to 2%.
Inflation expectation also refers to the long-term inflation expectation, which for the U.S. is also closer to 2%.
The term premium is also a straightforward concept that explains that investors must be compensated with more returns for a longer time horizon. As a safe and stable country, the US often does not have a high-term premium, but it still exists and can vary from a few basis points to a full percentage. As an example, the ten-year bond of Mexico will have a higher term premium than the U.S., and the Argentinian 10-year bond will likely have a higher term premium than Mexico’s bond.
So which one of these three factors is causing the rise in the long end of the curve?
The answer is inflation expectations. The thinking is that if the Federal Reserve cuts rates prematurely and inflation sparks back up, this could be the reason that the 10-year treasuries should spike higher. Higher inflation expectations, in the long run, will mean higher rates for the overall economy.
What is my take?
I can’t entirely agree. AI and technologies, in general, are deflationary, and if we believe AI is this revolutionary technology, the impacts should be more deflationary than inflationary. I believe the move in the yields is overdone, and we should see some relief in the yields in the coming weeks.
Assume the Position
One new position was added this week, and this was a risk reversal for Boeing, ticker BA 0.00%↑. While I am not a fan of Boeing for the long term, I set up a short-term 5-month trade on this name via a risk reversal. In this risk reversal strategy, I sold the $115 puts in February and used the premium to buy the $170 calls. This is a play on a potential short-term bounce on the name. Each contract pair cost $4.92. My target is to sell each contract at ~$12.00.
I continue to sell puts on TLT 0.00%↑ and REM 0.00%↑ as my long-term bet that the yields will come lower.
Last Words
As many of you have seen, most of the charts and analyses I use are from interactive brokers. Interactive Brokers provides some of the best commission structures, yields on idle cash, and, more importantly, one of the best tools for active trading. As an active options trader, I can only imagine myself trading with the tools that they have provided.
If you are still deciding, check out their free simulator and everything else they provide to help you get started.
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Disclaimer
The opinions provided in this newsletter are mine and mine only and do not represent any firm or other affiliation.
You understand that NO content published and discussed during this newsletter constitutes a recommendation that any particular investment, security, portfolio of securities, transaction or investment strategy is suitable for any specific person.
You further understand that I will NOT advise you personally concerning the nature, potential, value or suitability of any particular investment, security, portfolio of securities, transaction, investment strategy or other matter.
This presentation and the content provided are for educational purposes only.