Zweig Bond Model Signals What ETFs To Be In

July 19, 2016

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Steve Blumenthal, chairman and chief executive officer of King of Prussia (greater Philadelphia area), Pennsylvania-based CMG Capital Management.

Most analysts missed the great bond rally of the last two years. The Zweig bond model, explained below, provides a disciplined, rules-based way that may help you better navigate and profit from the up and down trends in interest rates.

In December 2014, Wall Street analysts predicted a rise in interest rates. At that time, the 10-year Treasury was yielding 2.75%. Consensus was for a move to 3.25% by year-end 2015. They missed. The yield finished 2015 at 2.25%.

In December 2015, Wall Street analysts predicted a rise in interest rates. You may recall the Fed's December 2015 rate increase with expectations for three more rate hikes in 2016. Once again, few expected rates to decline. But, boy, have they. The 10-year Treasury note recently touched 1.37% and is now yielding above 1.5%.

The decline in yields from 2.25% to 1.45% puts the iShares 20+ Year Treasury Bond ETF (TLT | A-83) up 16.13% year-to-date, as of July 15, 2016.

What The Zweig Bond Model Signaled

The Zweig bond model kept investors invested in long-duration bond ETFs over that challenging period, when the majority of analysts were calling for higher rates. Gains in the bond market have outpaced gains in the S&P 500 Index over the past 12 months, with TLT gaining 20.05% and the SPDR S&P 500 ETF Trust (SPY | A-97) gaining just 4.16%:

Chart courtesy of StockCharts.com

 

Now, the "U.S. corporate pension industry is throwing its interest-rate assumptions out the window," says Shyam Rajan, head of U.S. interest rate strategy at Bank of America. BofA is forecasting the yield on the 10-year note will fall to 1.25% by September (source: Bloomberg). Lower for longer is the current mantra, but with rates so low, risk is high.

J.P. Morgan, for example, is calling for 1.40% by August, 1.65% by September and 1.70% by Dec. 31. 

 

*Rounded to the nearest 5 bp

 

With the 10-year yielding above 1.5%, one has to question that yield return relative to the risk that investors will face when rates rise. A move to 1.70% by Dec. 31 will result in a loss in value of approximately 3% in the value of 10-year Treasury notes.

Further, you have to also wonder just how much help 1.5% will give your portfolio. In a traditional 60/40 mix, 40% of 1.5% over 10 years doesn't do much for you. And this is before inflation is factored in.

 

So, What To Do With Bonds?

I've long been a fan of the great Marty Zweig. In the mid-1980s, Marty and Ned Davis Research (NDR) created the Zweig bond model. Back then, the world was dealing with a rising interest rate environment. The 10-year yield peaked at 14% in 1984.

We did some work with NDR and recreated the simple trend-following model, and we use it internally to help us invest in longer-dated bond ETFs or switch to shorter-dated bond ETFs, such as the SPDR Barclays 1-3 Month T-Bill ETF (BIL | A-62) or the PIMCO Enhanced Short Maturity Active ETF (MINT | B).

It kept us invested in high-quality, longer-dated bond ETFs despite the fundamental forecasts that called for higher interest rates. As the axiom goes, "Let the trend be your friend."

5 Steps To The Model

It is a simple process and you can do this yourself. There are five steps to the Zweig bond model's scoring process:

  1. Score a +1 when the Dow Jones 20 Bond Price Index (index symbol $DJCBP) rises from a bottom price low by 0.6%. Score a -1 when the index falls from a peak price by 0.6%.
  2. Score a +1 when the Dow Jones 20 Bond Price Index rises from a bottom price by 1.8%. Score a -1 when the index falls from a peak price by 1.8%.
  3. Score a +1 when the Dow Jones 20 Bond Price Index crosses above its 50-day moving average by 1%. Score a -1 when the index crosses below its 50-day MA by 1%.
  4. Score a +1 when the Fed Funds Target Rate drops by at least 0.50%. Score a -1 when the rate rises by at least 0.50% point. Score +1 if a buy and -1 if a sell.
  5. Score a +1 when the yield difference of the Moody's AAA Corporate Bond Yield minus the yield on 90-day Commercial Paper Yield crosses above 0.60%. Score a -1 when the yield difference falls below -0.20%. Score it 0 for a neutral score between -0.20% and 0.60%.

Next, sum the scores of steps 1 through 5 once a week. The current reading is +3. (The chart below reflects calculations as of close on July 11. See yellow highlight bottom right-hand corner.)

 

Zweig Bond Model

For a larger view, please click on the image above.

 

If the total is +1 or higher, we would suggest considering a total bond market ETF such as TLT, the Vanguard Extended Duration Treasury Index Fund (EDV | C-50), the Vanguard Total Bond Market Index Fund (BND | A-94) or the iShares Barclays Aggregate Bond ETF (AGG | A-98).

If the aggregate score is -1 or lower, we would suggest considering BIL or MINT.

Let The Trend Be Your Friend

The objective is to stay in line with the bond market's primary trend.

With interest rates at 5,000-year lows, one has to take a step back and consider solutions that can better manage risk. We are living in a highly unusual and experimental central bank policy world. Yet there are ways for you to make money, using the broad set of tools ETFs provide.

The Zweig bond model is posted every Wednesday on my Trade Signals blog.

At the time of writing, CMG Capital Management owned all of the securities referenced above. Steve Blumenthal writes a free weekly economic research letter that covers valuations, probable forward 10-year returns, global macro issues and investing. Each week, you'll find a link to trade signals, which includes the most recent Zweig Bond Model chart. You can sign up here to receive his weekly On My Radar e-newsletter.

 

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