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How to Trade the Spike in Interest Rates

By Jeff Clark
Thursday, December 16, 2010

All of a sudden, everyone is talking about higher interest rates.
It's the most popular topic on many financial blogs. The talking heads on CNBC have been squawking nonstop about it for the past two days. I even overheard a couple golfers talking about it on the driving range yesterday.
What a difference a few weeks makes.
Two weeks ago, nobody cared that interest rates were rising. Two months ago, the entire world seemed convinced the Fed could push long-term interest rates even lower. But we thought differently, and we talked about it here, here, and here. It was a classic contrarian argument. If you joined us and bet on an increase in long-term interest rates, you've turned a tidy profit.
Now, however, betting on higher interest rates is no longer a contrarian trade. It's downright mainstream.
So while I'm flattered the rest of the world has come over to our way of thinking, I'm worried the "higher interest rate" trade has become too crowded too fast. All the bond market bears are huddled on one side of the boat. The odds are good the market will do something to toss them overboard.
Please don't get me wrong. The 30-year bull market in bonds is over, and interest rates are going higher over time. There's no doubt about it.
We've seen a dramatic increase, however, in just the past two months. So the market is due for a short-term, counter-trend move.
Here's an updated chart of the 30-year Treasury yield...
The red lines on the chart represent various support and resistance levels. They're good price targets for moves on the way up, and they provide support (and good trade-entry levels) for moves on the way down.
The numbers on the chart annotate the short-term price moves, or "waves," within the chart pattern.
Without getting too complicated... when a chart reverses from a bear market to a bull market pattern, it does so with a five-wave move. In other words, there's a series of higher highs and higher lows that unfold in five distinct moves as illustrated on this chart.
So there's no doubt interest rates are now in a long-term bull market and are headed higher over time.
However, the initial five-wave pattern is now nearing completion. Following this, markets typically correct in a three-wave move lower before resuming the uptrend. Given the sudden and tremendous shift in bearish bond sentiment, the timing seems just about right for the start of that three-wave correction.
If you'll allow me to gaze into my crystal ball for a moment, here's what I see happening...
The first move lower in rates should find support at 4.3% (43 on the chart) and bounce slightly higher to complete the second wave. The third and final move could push long-term rates down to 4.1%. That was a key breakout level in November as rates were moving higher. It should be strong support for any correction.
If you've profited off the move higher in interest rates so far, congratulations. Now it's time to take some profits off the table. Look for a move back down to 4.3% or 4.1% as an opportunity to jump back into the trade.
Best regards and good trading,
Jeff Clark

Further Reading:

Jeff has been calling the rise of long-term interest rates over the last few months. And as he notes, you'd have turned a handsome profit if you followed his advice. Watch how these trades played out over the last few months here, here, and here.
Larsen Kusick recently showed Growth Stock Wire readers an overlooked area of the tech sector flashing a big buy signal. "This is a huge, long-term trend that could be good for hundreds of percent gains," he writes. "And it's just getting started." He describes four stocks worth watching here: Tech Investors Are Ignoring the Start of a Big Bull Market.

In The Daily Crux
Market Notes
"Safe" treasury fund TLT already down 7% this month.
Big machinery trend keeps rolling… new highs for Caterpillar, Cummins, and CNH Global.
Copper prices soar 8% in December as gold prices fall slightly.
Natural gas trend under pressure... prices fall 10% over the past week.
Market Watch
Symbol Price
S&P 500 1235.23 -0.5% +11.5%
Oil 37.99 +0.2% +5.7%
Gold 134.70 -1.1% +22.2%
Silver 28.08 -2.5% +64.3%
U.S. Dollar 79.38 +0.1% +3.2%
Euro 1.32 -1.3% -9.1%
Volatility 17.94 +1.9% -16.6%
Gold Stocks 567.07 -1.9% +28.8%
10-Year Yield 3.52 +2.0% -2.2%

World ETFs
Symbol Price
USA 124.10 -0.5% +11.5%
Canada 30.57 -0.2% +18.1%
Russia 22.11 -0.6% +22.1%
India 36.64 -2.8% +20.5%
Israel 17.18 +0.4% +13.3%
Japan 10.69 -0.7% +8.2%
Singapore 13.44 -2.3% +17.0%
Taiwan 15.01 -0.2% +20.2%
S. Korea 57.55 -1.8% +21.1%
S. Africa 71.76 -0.8% +27.4%
China 42.76 -2.3% -1.2%
Lat.America 52.01 -1.3% +7.3%

Sector ETFs
Symbol Price
Oil Service 135.47 -1.3% +15.4%
Big Pharma 65.47 +0.2% -1.9%
Internet 72.42 -0.2% +28.4%
Semis 16.14 -0.9% +26.2%
Utilities 31.08 -0.9% -2.2%
Defense 18.49 -0.6% +7.3%
Nanotech 9.95 +0.0% -1.2%
Alt. Energy 10.20 -0.4% -5.8%
Water 19.24 -0.2% +14.5%
Insurance 16.46 -0.1% +20.4%
Biotech 21.49 +0.8% +31.0%
Retail 19.55 -0.1% +24.9%
Software 25.08 -0.4% +25.5%
Big Tech 54.16 -0.4% +22.3%
Construction 13.58 +0.2% +15.6%
Media 13.82 -0.9% +19.5%
Consumer Svcs 66.98 -0.4% +20.3%
Financials 55.92 -0.9% +9.4%
Health Care 65.52 -0.1% +2.1%
Industrials 64.45 -0.5% +20.1%
Basic Mat 74.43 -0.8% +26.1%
Real Estate 53.65 -1.1% +18.5%
Transportation 90.87 -0.4% +21.0%
Telecom 23.12 -0.5% +17.2%

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