Which Will Fail First, Treasury Bonds or Transportation Stocks?
NEW YORK (TheStreet) -- We are finally getting past all the bad weather-related news from the first quarter of the year. The stock market and bond market are firmly higher for the year to date.
Within the S&P 500 one of the leading sectors are transportation stocks. Using the iShares Transportation Average ETF (IYT) as a proxy, through Tuesday's close it had a total return of 11.03%. Not bad considering the polar vortex shut many roads down for days at a time to start 2014.
The bond market also has had quite a good start this year. The iShares 20+ Year Treasury ETF
(TLT) is up an almost identical return of 11.87% so far. Most pundits expected that the rising interest rate trend from 2013 would have continued this year. On Dec. 31 the 10-year Treasury stood at 3.05%, while the 30-year Treasury closed at 3.96%. Recently, the rates were 2.58% and 3.41%, respectively.
As investors know, there is a direct, inverse relationship between interest rates and bond prices. Therefore, these lower rates mean bond prices are higher.
While these two sectors have almost equal returns, something seems amiss to me as a student of the market. Usually Transport stocks go up in an expanding economy while interest rates fall (higher bond prices) in an economy that's contracting. These factors are not congruent with the returns we are experiencing so far. One would believe that one of these sectors is almost certain to fall while the other could continue to expand. So which is it? An argument could be made in light of the recent revision of the first-quarter GDP to -1% that the economy is contracting, and sticking with the Treasury trade is the way to go. However, most investors believe much of that contraction was weather-related and the old GDP data are being unseated with new economic indicators that show economic growth in the second quarter. Another contributing factor to these lower rates may be a result of the Federal Reserve buying a higher percentage of new Treasury issuance. Strategas has done some research that found on a rolling six month basis, in spite of the tapering of quantitative easing, the Fed has purchased 73% of the new Treasury bonds issued. This is near the highest levels of all time -- which would contribute to higher bond prices because that would only leave 27% of new bonds available for all other potential buyers. Supply demand increases usually results in higher prices. My hope is the economy continues to expand and the stock market goes higher. While IYT has a Price to Earnings ratio of 22 that is rich to the market, it is by no means overvalued. I have a long-term price target of $162 for IYT, which now trades at $144.80 after closing Tuesday at $144.90. That's not to say a pullback to $131.25 can't occur, but the momentum is for further appreciation for that sector. TLT, on the other hand, currently at $111.14, is facing some technical resistance near last week's highs in the $115 per share range. If the economy can show strength as QE is pared back, interest rates should begin to rise again and TLT will fall. We saw the 20-day moving average get breached to the downside when TLT closed at $111.57 Tuesday. The reversal may be coming sooner rather than later. At the time of publication, the author held no positions in any of the stocks mentioned. Follow @pfpinvest This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff. >>Read more: Friday's Jobs Report Won't Alter Fed Plans to Raise Interest Rates
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