It’s not every week that the yield on the 10-year treasury jumps nearly 60%, so when it does, it’s worth taking notice. On Tuesday, February 15th the 10-year closed yielding 1.265%. By Friday the 19th, that number had jumped to 1.34%. At month’s end, it stood at 1.44%.
Of course, the yield is still low by any non-pandemic historical measure, but as is often the case with Wall Street, the magnitude and the speed of the move matter as much or more than the absolute level. The reasons behind the rise can be generally seen as positive: a decline in the number of coronavirus cases and an acceleration in the rollout of the vaccine; the increasing likelihood of a massive new stimulus package; and a growing conviction that the economy is poised to accelerate (although the pace of that rise could be problematic).
Any or all these developments can be seen as inflationary as well. Coming off a year in which consumer demand has been suppressed by the lockdown, there’s been relatively little upward pressure on yields. But now there’s a belief in some parts of the market that we’re entering a period of reflation and that prices are about to move higher.
For us, that remains to be seen, but the market has lately been reacting as though it’s a reality, and some investors are beginning to position for it. A February 22nd, Bloomberg story cited one fixed income ETF that had seen nearly $7.5 billion in withdrawals over a six-week period and noted that short sellers were building positions in another fund focused on 20+ year treasuries.
Certainly, the market is experiencing a few jitters as evidenced by the sharp sell-off on Feb 25. While multiple strategies are available to help navigate through this, one that has demonstrated value in the past is a diversified position in liquid alts and liquid alt ETFs. These funds can help reduce volatility while continuing to generate income and maintaining a presence in the markets.
One example is the IQ Hedge Multi-Strategy Tracker ETF (QAI), which provides exposure to six main hedge fund strategies. The fund is designed as a low beta alternative to the equity markets. A second is the IQ Merger Arbitrage ETF (MNA). Research has shown that merger arb returns tend to go up as rates rise. In addition, the strategy has a low correlation with the broader equity markets, and can act as a volatility dampener for a portfolio.
Another fund option, though not technically a liquid alternative, is the IQ Real Return ETF (CPI) which invests in a broad range of inflation-sensitive asset classes with the goal of delivering a return above the rate of inflation as represented by the Consumer Price Index (CPI). It can, among other things, serve as an alternative to TIPS in a portfolio.
With a few exceptions, bond yields have generally been moving down since the 1980s, so long that it is likely an entire generation now has little to no experience with serious inflation. The end of that bull market has been much predicted but not yet seen. It may turn out that this, too, is a passing phase, with bond prices just normalizing to pre-pandemic levels.
Still, there are a lot of factors that argue in favor of rising yields. Just last week the government reported a 1.3% rise in the Producer Price Index (PPI) for January, the biggest increase since 2009. On a trailing 12-month basis, PPI rose to 1.7% last month from 0.8% at year-end 2020. Much of this was attributed to a rise in gasoline prices, which is likely to prove transient, but the rise in energy costs itself has been driven in part by an increase in economic activity. The Consumer Price Index has been more quiescent, up just 0.3% in January and 1.4% over the trailing 12 months. Nothing much to see there. Yet.
There is, we believe, a lot of money sloshing around. The 5.3% jump in retail sales for January (NY Times; 2/17/2021) is most likely the result of how fast stimulus checks are finding their way into the economy. And, if the Biden Administration is successful in getting its plan through Congress, another $1.9 trillion is on the way. There is early pressure building on wages as well, as jobs return.
Inflation is never a problem until it is. When it does emerge, it can do so in a hurry. Assets like gold have been seen in the past as the first line of defense, but that may be changing. Options like liquid alternatives we believe can offer a better way to protect against a rise in general price levels, while generating income and maintaining broad asset class exposure.
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BETA is a measure of historical volatility relative to an appropriate index (benchmark) based on its investment objective. A beta greater than 1.00 indicates volatility greater than the benchmark’s.
CPI The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services.
TIPS Treasury inflation-protected securities are a type of Treasury security issued by the U.S. government.
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