The sudden appearance of higher rates on the investment scene has caused some major heartburn over the past week or so, and in our opinion, rightfully so. Higher rates were unexpected and not factored into most participants' forecasts; therefore stock prices were not reflecting the risk of rising rates.

The increase in rates does have a potentially very real impact on stock prices and the positive forces that have been driving stocks higher. The LBOs, corporate buybacks, mergers, earnings and just general supply of cheap money that have been flowing into the stock market are suddenly all at risk.

The initial reaction we have been seeing is the knee-jerk move. The recent weakness is due to adjustments being made by traders as they realize that higher rates need to be considered. There is plenty of jockeying going on as investors decide whether this is a short-term spike or a longer-term trend change in interest rates. This has led to some extreme volatility in stock and bond prices over the past week.

SARSI Indicator vs. 30-year Treasury Yields

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When these situations arise, we find it's best to look at the evidence we have and avoid making dire predictions and emotional arguments or decisions. We prefer the step-by-step approach and to evaluate the situation based on status.

In this regard, our internal SARSI indicators, a measure of momentum and short-term money flow, have reached an important level with the closed-end bond fund sector. There is no other equity group that is more sensitive to rates than closed-end bond funds, as they are, in essence, an equity that is based on underlying bond prices.

The 40-day SARSI indicator in the closed-end bond sector has reached oversold levels. This is reflected in the quick reactionary decline in bond prices and rise in rates. These oversold readings have historically been a good indication that a decline on an intermediate-term basis has reached extreme downside momentum and that the selling is largely complete.

Typically, once the oversold reading moves below 20%, the sector is within five to seven trading days of finding a low in price. It's simply a case of the selling having exhausted itself temporarily. Interestingly, the oversold signals in the closed-end bond sector have coincided with lows in bond prices and a peak in interest rates.

This tells us, while it seems from a sentiment standpoint otherwise, we should be looking for rates to ease off their recent rally and begin to pull back or, at a minimum, move sideways. This initial reactionary move is close to having run its course, and the damage to bond prices has occurred for now. These signals have been excellent buying opportunities, and we would look to get long the closed-end bond funds for a move higher of some magnitude.

There are over 400 closed-end bond funds, each specializing in some aspect of fixed-income, from municipal bonds to high-yield corporate debt. The easiest and purest way to play a relief rally in bond prices would be to buy one of the iShares that track government debt.

iShares Lehman 20-plus-year Treasury ETF

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We are focusing on the

iShares Lehman 20-plus-year Treasury ETF

(TLT) - Get Report

, the iShare for the 20-plus-year Treasury and the

iShares Lehman 10-year Treasury ETF

(IEF) - Get Report

, the seven- to 10-year Treasury duration.

iShares Lehman 10-year Treasury ETF

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Both ETFs have had a sharp decline, but are now on long-term support. As we discussed above, the oversold readings suggest this is a low-risk entry on the long side for a trade higher. We would use a 50 % retracement of the recent declines as a good upside price target for now.

At the time of publication, Scott Maragioglio had no positions in the stocks mentioned. Maragioglio had more than 15 years of technical analysis and money management experience before co-founding Epiphany Research. Epiphany Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indexes and sectors. He is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Mr. Maragioglio has also served on the board of directors of the AAPTA.