Chart of the Week: Record Low Yields for the 2-Year U.S. Treasury Note

As noted a week ago in Revisiting the Flight-to-Safety Trade, there are a handful of ways in which to keep an eye on the pulse of investor anxiety. These include U.S. Treasuries (including the various ETFs, such as TLT, IEF and SHV), the dollar (UUP), and gold (GLD). In terms of volatility, the preferred vehicles are the VIX, VIX futures and VXX.

For the last two weeks or so, stocks have been under considerable pressure, yet the action in the dollar, gold and volatility have been relatively mild and far short of panic. One has to look at U.S. Treasuries to see signs of extreme anxiety in the charts. This week’s chart of the week below shows weekly bars of the yield on the 2-Year U.S. Treasury Note going back four years. The yield on the 2-Year Note reflects an amalgamation of several factors, including the Fed’s easy money policy, potential deflationary speculative plays and demand which results from the flight-to-safety trade when investors are fearful of owning stocks, commodities and other investment vehicles. While it is difficult to disaggregate the component influences on the yield, it is safe to say that the record low yields seen last week include an important flight-to-safety component and are an excellent proxy for investor fear and anxiety.

For some of my thinking on why the VIX was unusually sluggish last week, see Impromptu VIX Talk, where Adam Warner (Daily Options Report) and I confirm that once again we have independently arrived at the same conclusions regarding volatility. [For those conspiracy theorists who wonder why we have never been seen in the same room, perhaps Adam's capture of our IM banter will quell thoughts of the ghost blogger typing away on the grassy knoll.]

For more on related subjects, readers are encouraged to check out:

• Chart of the Week: 10-Year Treasury Note Yield
• Revisiting the Flight-to-Safety Trade
• Yield Curve Looks Just Like May 2003
• The Battle for Bond ETF Supremacy

[source: StockCharts.com]

Disclosure(s): short VIX and VXX at time of writing

Revisiting the Flight-to-Safety Trade

Once again the S&P 500 index approached the precipice at 1040 and for now at least has backed away and found a little breathing room.

With anxiety running high, investors have embraced the flight-to-safety trade once again. The current preference is for U.S. Treasuries, the dollar (UUP), and to a lesser extent, gold (GLD).

While the most conservative plays are necessarily on the short end of the U.S. Treasury yield curve (represented by ETFs such as SHV and BIL), note that in the chart below I have included the long bond ETF (TLT) to provide a higher volatility bond for comparison purposes. The trend is fairly well established at this stage. Of the flight-to-safety vehicles, U.S. Treasuries are attracting the most interest (perhaps due to deflationary concerns), followed by gold, with the dollar the least enticing alternative, today’s 0.8% rally notwithstanding.

Not shown in the chart below is VXX (iPath S&P 500 VIX Short-Term Futures ETN), which is more of a speculative bear market play or a hedge than a flight-to-safety alternative. During the period from the April 23^rd high through yesterday (June 28^th) VXX is up 53.4%, with a volatility level of 94.5.

For more on related subjects, readers are encouraged to check out:

• Chart of the Week: The Flight-to-Safety Trade
• Chart of the Week: 10-Year Treasury Note Yield
• Yield Curve Looks Just Like May 2003
• The Battle for Bond ETF Supremacy

[source: ETFreplay.com]

Disclosure(s): short VXX at time of writing

Chart of the Week: The Flight-to-Safety Trade

This week’s chart of the week looks at some of the various flight-to-safety trades that investors have been taking advantage of since the recent closing high of 1217 in the S&P 500 index from April 23^rd.

In the chart below, note that first gold (GLD) and then the dollar (UUP) peaked as hedges against stock declines. More recently, U.S. Treasuries have been the favored flight-to-safety vehicle, with the long bond ETF (TLT) outperforming the other two alternatives and shorter-term Treasury ETFs such as IEF, not shown, attracting quite a few buyers.

Also not shown in the chart below is VXX (iPath S&P 500 VIX Short-Term Futures ETN), which is more of a hedge than a flight-to-safety alternative. During the last month VXX is up 81.3%, with a volatility level of 113.6.

[source: ETFreplay.com]

Disclosure(s): short VXX at time of writing

The Battle for Bond ETF Supremacy

Over the weekend, there was an interesting MarketWatch.com article, "In come more bond ETFs: Vanguard enters wide-open market as Barclays throws out the 'junk,'" about the battle for bond ETF supremacy between Barclays (BGI) and Vanguard, with BGI landing the first few punches. Two items in particular caught my interest:

1. BGI's launch of the first high yield ETF, the iShares iBoxx High Yield Corporate Bond Fund (ticker HYG); and
   
2. the very low 0.11% expense rates for the Vanguard bond ETFs

Specific to VIX, volatility and risk, I can see future applications involving the use of a high yield ETF with a government long bond ETF like TLT to look at ratio charts (unfortunately, StockCharts.com does not yet have HYG in their database,) price differential charts, etc. This type of analysis might turn out to be a good complement to the Markit Credit Default Swap data.

Looking more at the “…and More” side of the ledger, here are a handful of ETF-related links that I get a lot of value from:

• ETF Trends – an excellent site that is dedicated to general ETF news
  
• Yahoo ETF Center – where you can sort and filter all the nearly 500 ETFs that Yahoo has in their ETF database
  
• a February Kirk Report ETF link fest – the top 20 ETF links as selected by his readers
  
• iShares splash page
  
• ...and for those that may be interested, my favorite ETF blogger is Roger Nusbaum (a.k.a. Random Roger)

Finally, while the bond ETF field is already getting crowded, I thought I might point out a half dozen ETFs that have consistently high volume and consequently are as appropriate for trading as they are for longer term investing:

• SHY - iShares Lehman 1-3 Year Treasury Bond Fund
• IEF - iShares Lehman 7-10 Year Treasury Bond Fund
• TLT - iShares Lehman 20+ Year Treasury Bond Fund
• AGG - iShares Lehman Aggregate Bond Fund
• LQD - iShares iBoxx $ Invest Grade Corp Bond Fund
• TIP - iShares Lehman TIPS Bond Fund

Stock or Bond Volatility?

Mike at HEDGEFolios.com is one of many out there who are wondering whether the VIX has outlived its usefulness, as the recent spate of single digit readings have sent many back to look for a better indicator. His suggestion: why not look at the volatility associated with the 10 Year Treasury Note instead of stocks?

Never one to let any untested idea stray too far from a spreadsheet, I examined the volatility of the 10 Year Note from 1990-2006 and learned that 2006 was the least volatile on record, with 2007 off to an even less volatile start. The correlation between the VIX and the 10 Year Note was .24 for the 17 year period, but jumped to .43 for the past decade and an impressive .99 for the last three years, as the chart below (with normalized values) demonstrates.

The current volatility of the 10 Year Note is still a fair distance from the historical lows of the summer of 1998, but as the VIX edges ever lower it is always a good idea to keep at least one eye on the long bonds.