TLT: Making a Parallel with 2018/2019 Points to a Temporary Upside for This Long Duration Bond ETF

During the week ending January 21, 2022, both the NASDAQ and S&P 500 were down by 5% and 3.9% respectively as shown in the charts below, while the Vanguard Total Bond Market (BND) was up by 0.72% showing investor preference for fixed-income over equities. More important, the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT) as shown in green below was up by a whopping 2.52%.

Source: Ycharts

Now, as its very name suggests, TLT seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. In short, it provides exposure to long-term U.S. treasury bonds.

Why invest in TLT

Quoted on the NASDAQ, TLT aims to replicate the performance of the ICE U.S. Treasury 20+ Year Bond Index. The fees for the ETF are 0.15% and the total assets under management are around $16.45 billion. There is also a dividend distribution policy encompassing yields of 1.54%. There are alternatives, one of which is the Vanguard Extended Duration Treasury ETF (EDV). This ETF, which I elaborated upon at the end of December, has delivered an even higher one-week gain of 3.33%.

Coming back to TLT, one of the advantages of this ETF is that it captures the long end of the yield curve in a very liquid fund. Thus, for investors who want long-term exposure to the U.S. Treasury, the quality of these bonds makes this ETF a safe haven in times of doubt. For example, during the financial crisis of 2008/2009, TLT rose by 28.3% while the S&P500 suffered a drop of 38.5%. For those who trusted it, TLT again provided portfolio protection in March 2020’s Covid-related market crash due to the fact that it is inversely correlated to the broader market.

Still, adopting a cautionary posture, as from the end of April 2020, when it was evident that the U.S. economy was exiting recession and the S&P 500 started its unrelentless uptrend, TLT started to underperform as investors moved away from the safety of long-duration bonds. Additionally, one should be aware that TLT is very sensitive to fluctuations in long-term interest rates given that it exclusively holds bonds over 20 years old.

For this purpose, extending the time horizon from one week to include 2021and January this year, one will notice that TLT’s share price (in orange in the chart below) moves inversely to the U.S. Treasury 10-year yields in the blue chart.

Source: Trading View

In addition to being interest rate-sensitive, TLT is also impacted by inflation as its yields remain moderate compared to higher yield bonds like BND which pays higher dividends of 2.16%. But, BND, in the same way as the S&P 500 suffered during the March 2020 market crash and in current market conditions, rising rates could overpower coupon returns.

One of the reasons I find TLT to be attractive at this particular moment in time is that it is in some way tied to the strength of the U.S. economy, not necessarily one which is growing at full steam, but rather one which is growing healthily with a balance between growth, on the one hand, and, inflation on the other. It is precisely this economic setup that the Fed is aiming for with the forthcoming normalization of monetary policy. Also called policy tightening, the aim is ultimately to reduce inflation while maintaining a reasonable growth potential.

I now make a parallel between events back in 2018-2019 and 2021-2022, with Jerome Powell heading the Fed during both periods.

Making a parallel with 2018/2019

Back in 2018, the performance of TLT (orange chart below) was highly negative or -10.5% from January to October as marked by the brown circle. However, there was a subsequent strong rebound of +7.7% since the beginning of November 2018, which also coincided with a fall in equity indices.

Source: Trading View

At that time, this was linked to growing uncertainties about the U.S. and global economies. Some of you may remember that the Fed, with Mr. Powell at its helm, remained firm on his intent to raise rates, more concerned about inflation rising than the weakening of U.S. growth.

Well, this is exactly the same today, except for the fact that inflation is already high.

Still, one of the lessons which can be learnt from 2018/2019 is that after 20 months of uninterrupted growth, the market is worried that the U.S. economy could take a pause in the coming months. To this end, the recent upside seen in TLT’s share price suggests that more investors are opting for long-term government bonds, which play the role of safe haven at times when the equity market corrects sharply.

Now, given the uncertainties, some of which revolve around the number of rate hikes, their economic impacts and what would be the market reaction, TLT may deliver a sustained upside. However, this will not be to the same degree as observed in 2018/2019 when there was a 25% upside over six months (the difference between the blue and brown circles). Moreover, contrary to 2018-2019, the consumer price index (CPI) is much higher today.

Pursuing along the same lines, TLT’s performance will also depend on how the markets digest the news during the forthcoming meeting of the Fed’s policymaking arm. That first meeting for 2022 is scheduled for January 25-26 and on Wednesday, Mr. Powell will conduct a press conference in what is expected to be the biggest such event since expectations about interest rates rising emerged. Consequently, we can reasonably expect long term bonds to continue performing well, at least till Wednesday.

Finally, TLT can be considered to be very useful as part of a risk-limitation strategy to mitigate for volatility in the equity market during periods of strong turbulence, but, for long term investors, it is important to note that it works better during periods of low inflation.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.