Summary
- Yields have ticked back up as economic data has been strong lately.
- The Fed's Terminal Rate is seen near 5.25% today, up from nearly 4.8% at the low last month.
- I see more downside ahead, but buying the dip at two key price levels could be the play.
Stocks and bonds are, at long last, moving in opposite directions. That is generally a good thing for long-term diversified investors. Right now, though, bonds are rolling over versus equities as a super-hot labor market and a recent spike in the Producer Price Index has yields on the rise.
It was just a few weeks ago that the 2-year Treasury rate was under 4.2% while the 10-year yield was below 3.5% (TNX is now at a 2023 high near 3.85%). The game changed following the tight January jobs report. Rate-sensitive bonds have come under pressure. Let's take a look at a broad gauge of the U.S. bond space: the iShares Core U.S. Aggregate Bond ETF ( AGG ).
Bonds Hedging Stocks Again
SPDJ Indices
According to the issuer , AGG seeks to track the investment results of an index composed of the total U.S. investment-grade bond market. That includes treasuries and corporates. With an expense ratio of just 0.03% annually, it is an easy and efficient way to get exposure to the so-called "40" part of the 60/40 portfolio. It's also highly liquid, with a median 30-day bid/ask spread as scant as it gets at just a single basis point and an average daily volume of more than 6 million shares.
AGG holds more than 10,000 pieces of paper and sports an average yield to maturity of 4.57%. With expected inflation in the 2.5% range over the coming 6 years (according to Morningstar ), its real yield is solidly in the black when compared with the effective duration.
Bond investors should not be afraid of higher rates so long as their holding period is at least a fund's average maturity. In terms of risk, the standard deviation (like the VIX for a security) is 6.1% as of January 31, so it is much less volatile than the S&P 500, but iShares reports that AGG does feature a slightly positive equity beta over the last 3 years.
AGG Duration: Down to 6.4 Years
Morningstar
Digging into the portfolio, AGG is more than 41% in treasuries with another 27% in MBS pass-throughs, which are also government-related, though not technically default-risk free. Industrial and Financial sector paper also comprises a chunk of AGG. 72% of total credit quality is AAA rated while about one-quarter of the fund is on the low end of investment grade.
Overall, I own AGG and see it as an ideal way to get broad exposure to the bond market. I'm a long-term investor and hold it in a tax-qualified account so that I do not pay annual taxes on distributions. Another strategy I agree with is to own low-return assets (like bonds) in taxable accounts so that you can keep high-growth-potential positions tax-sheltered to avoid big long-term gains down the road. Either works depending on your situation.
AGG: Mainly Government Fixed Income
Back to the markets, notice in the chart below that the bonds vs stocks chart has recently favored equity investors. AGG has fallen hard on a relative basis against the S&P 500 ETF (SPY) (total returns). I take it as a sign that bonds are relatively cheap here, and taking some equity risk off the table may be prudent given the SPX's third-best start to a year through Valentine's Day on record (h/t Ryan Detrick from Carson Group).
Stocks vs. Bonds: AGG Near Range Lows
Let's home in on AGG's absolute chart. This look is not so sanguine for AGG. I see a trend line break off the October low, with support at the late 2022 dip. Shares were unable to hold above the falling 200-day moving average as they met significant selling pressure from a high supply of shares as evidenced by the volume by price indicator on the left.
Moreover, the recent peak came on a bearish negative RSI divergence. Overall, downside momentum appears on the way. But with a bigger yield now compared to months ago, that helps offset NAV declines.
AGG: Bearish Divergence, Shares Eye $97
The Bottom Line
With a bearish absolute chart with some near-term support a bit beneath the current price and a more bullish relative chart, I am a hold on AGG. Buying on a move to $97 and backing up the truck near $94 look like good moves.
For further details see:
AGG: YTM Rising As Shares Break Trendline Support, Downside Momentum May Continue