Stock Analysis & Ideas

TLT ETF: Bond ETFs in a Sad Situation, Ahead of Fed Announcement

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The Federal Reserve is about to announce changes that will impact both the stock and bond markets. If the Fed’s not likely to ease up on its rate-hike path, it’s crucial to be on the right side of the trade with TLT stock.

iShares 20+ Year Treasury Bond ETF (TLT), which we can informally refer to as TLT, has an unusual relation to bonds that investors need to understand. I am bearish on TLT shares because the Federal Open Market Committee (FOMC) is about to make some important announcements today. Most likely, Federal Reserve Chairman Jerome Powell is going to set a hawkish tone, which is bullish for bond yields but could cause price damage to TLT.

TLT straddles the realms of stocks and bonds, as it’s an exchange-traded fund (ETF) that has characteristics of both asset classes. This shouldn’t be off-putting to investors, though, as TLT is an important trading tool, and it’s not too difficult to learn how it works.

Besides, with the Federal Reserve (or “Fed”) about to set the pace for bond yields and for central bank monetary policy generally, there may be a profitable trade afoot with TLT stock. So, let’s dive right in and get the lowdown on this unusual but essential fund.

TLT is Low-Expense and Gets the Job Done

High fees and other expenses can weigh on your portfolio’s bottom line over time. Thankfully, the TLT ETF is a low-expense fund that faithfully fulfills its purpose – which is great, as long as you know what TLT’s purpose is.

According to iShares, the iShares 20+ Year Treasury Bond ETF “seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years.” This description might sound long and complicated, much like the fund’s name, but it’s actually based on a simple concept.

U.S. government bonds or “Treasurys” (yes, it’s actually spelled that way) can expire or “mature” in a few months, a few years, or even as long as 30 years. The longer-dated Treasurys typically offer higher yields than the shorter-dated ones unless there’s a so-called “yield curve inversion.”

When Treasury yields go up, the prices of those bonds actually go down because now investors can buy higher-yielding bonds, so the bonds you already owned aren’t as valuable, comparatively speaking. Therefore, there’s an inverse correlation between bond yields and bond prices.

The purpose of the iShares 20+ Year Treasury Bond ETF is to track U.S. government bond prices, not their yields. So, when iShares states that TLT provides “exposure to long-term U.S. Treasury bonds,” don’t get the wrong idea.

Notably, TLT stock’s annual expense ratio is quite low at just 0.15%. So, the fund’s managers don’t charge very much – but this won’t provide much consolation if TLT loses significant value in the near future.

If the Federal Reserve Stays Hawkish, TLT is Likely to Fall

On the afternoon of November 2, Powell will make announcements on behalf of the FOMC concerning the future of American monetary policy. The stock and bond markets will comb through Powell’s every word, looking for accommodative/dovish or restrictive/hawkish language. If the Fed chair says anything that sounds hawkish, TLT stock could plummet that day and over the following weeks.

It’s no secret that the Fed has been hiking interest rates in order to bring down high U.S. inflation. Unfortunately, the Personal Consumption Expenditures or PCE Index, which is often considered the Federal Reserve’s preferred inflation gauge, rose 5.1% year-over-year in September. This marks an increase from August’s 4.9% reading, so inflation seems to be going in the “wrong” direction for the Fed to ease up on interest rate hikes.

Additionally, the Consumer Price Index or CPI, another commonly cited inflation gauge, barely budged from 8.3% in August to 8.2% in September. Again, there’s little to no incentive here for Powell to make any dovish-sounding pronouncements or to stop raising Treasury yields aggressively.

Thus, the long-dated bond yields that the TLT ETF tracks are likely to lose value as their yields rise during the coming days and weeks. This could happen quickly and sharply as the bond market is forward-looking and, lately, driven by anxiety.

Conclusion: It’s Probably Not the Right Time to Own TLT

The iShares 20+ Year Treasury Bond ETF does have its advantages. It offers exposure to the bond market without actually having to purchase bonds. Plus, TLT stock is highly liquid and has a very low expense ratio.

On the other hand, the last thing you want to do as an investor is “fight the Fed,” as they say. So, don’t assume that a bond-focused ETF like TLT is going to sail higher if the Federal Reserve stays hawkish. Most importantly, it’s probably not a wise idea to jump into a long position with TLT stock as long as America’s central bank is committed to fighting persistently elevated inflation.

Disclosure

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