There are five things you should never do in the Florida Republic.
- Forget your sports coat at home.
- Run out of Long Drink when company visits.
- Talk politics on the beach, at the bar, or anywhere there’s company.
- Misquote the movies Caddyshack! or The Big Lebowski.
- Try to catch a falling knife in a negative equity momentum market.
Now, the first four are simple. They’ll be on the entrance exam…
But understanding what a falling knife means in the market?
This is a damn important lesson in finance.
You see, I keep getting the same question about when it’s a good time to start buying bond ETFs in this market, especially after an epic selloff in recent years.
Today, I’ll give you that answer…
Pour yourself a Long Drink, and I promise to make this quick.
Ride of the Bond Vigilantes
What does it mean to try to “catch a falling knife?
The phrase “catching a falling knife” is a metaphor used by investors to describe the risky behavior of trying to buy an asset (like a stock or a commodity) that is plunging in value.
You can visualize what might happen to your hands when you try to catch a blade falling at terminal velocity.
In the markets, the risks of trying to time an equity’s bottom can lead to very dangerous outcomes. There are several reasons to avoid this practice.
First, a sharp decline in an asset’s value often produces a lot of volatility and uncertainty. If you try to catch a falling asset (buying it indiscriminately), you don’t know if the decline will stop or if it will continue dropping.
Even a surprise price rebound can quickly lead to additional downside, as algorithms take advantage of quick price action and sell when they produce a profit (remember, the purpose of a market is to sell.)
Second, you can’t rely on fundamental or technical analysis when certain assets start to drop precipitously. A steep decline could be due to fundamental issues or negative news like company scandal or poor financials. It could also be a major macroeconomic event like war or a pandemic. If you rely on technicals, something might look oversold, but sharp price declines can disrupt traditional technical patterns and momentum indicators. All your textbooks quickly go out the window.
Third, human psychology is very dangerous in these scenarios. We are much more sensitive to losses than to our gains. So, when assets fall and continue to decline, they can create emotional and financial damage. Despite the clear logic to avoid the situation, we might not sell when we should or be tempted to double down on a failing trade or investment.
This presents a fourth important challenge: When trying to catch a falling knife, we may not have an exit strategy in mind, or we may find ourselves breaking important risk management rules that allow us to protect the principal.
Finally, I stress the importance of recognizing that you have finite amounts of capital. Instead of trying to catch a falling knife and imagining that you could double your money quickly, consider that there are other opportunities in the market. Instead of trying to time the market, you might look to allocate capital to more conservative opportunities or wait for clear signs of stabilization.
Here in the Florida Republic, we use fundamental and technical analysis, but we never try to call a bottom in anything.
Instead, we wait for the market to come to us.
That’s why we use our Equity Strength Signals to tell us when capital flows into the market or into a sector and when it’s flowing out.
We might miss the early bidding from oversold conditions, but we are never left holding the bag if something starts sliding quickly.
Yesterday, we saw our readings turn positive, but today they went sideways, creating an easy exit, and we’ll wait for the next opportunities.
Janet Yellen’s Falling Knife
Finally, I want to discuss the biggest “falling knife” in today’s markets.
That’s the BlackRock Institutional Trust Company N.A. – iShares 20+ Year Treasury Bond ETF (TLT).
The TLT tracks the performance of the ICE U.S. Treasury 20+ Year Bond Index, which includes U.S. Treasury bonds with maturity dates of 20 years or more.
Many investors like this because it exposes them to long-term U.S. government bonds. And since U.S. government bonds are very unlikely to face default, investors think this is a safe fund.
But it’s not. Not even close.
In fact, Syz Group dubbed it one of the worst “cash incinerators” of the past few years.
It’s burned over $10.7 billion in wealth (lifetime flows minus today’s AUM).
Sources: Syz Group, Psarofagis thru Eric Balchunas, Bloomberg
Year-to-day, the ETF is down 16.7%.
Finviz
Pull back to the height of COVID, when the Fed cut interest rates to zero, and this long-term bond fund is now down more than 50%.
It’s a good reminder of all the banks and institutions holding long-duration bonds now sitting on untold unrealized losses.
The TLT is in a freefall as U.S. interest rates continue to rise.
This chart tells us two things. First, the bond market is screaming at the U.S. Treasury to stop spending money. But we know that this isn’t set to happen.
Second, the cost of borrowing for the U.S. Treasury is likely heading higher.
How much higher? Well… that’s anyone’s guess.
And since no one does know, trying to time this ETF is a fool’s game.
I’ve seen plenty of experts try to call the bottom of this bond market, only to see it get worse and worse.
My advice: Stop doing this.
Midjourney: Florida Man tries to catch Falling Knife, 1977
Because the last thing you want to be is the person without a chair when the music stops.
If bond ETFs like this one face “Zero Bid” – where no one wants to buy it…
There will be no floor and no stop to protect you.
This is the most dangerous falling knife today.
Steer clear.
And remember: For every one person who will brag in the future that they timed their purchase right on the TLT, there will be hundreds of others you never hear from – who will stand with their hands and portfolios bloodied by this ETF.
We’ll be back tomorrow to discuss bonds and energy opportunities.
Stay positive,
Garrett Baldwin
Secretary of Defense
