The bond market reversed off multi-year highs on Wednesday after yields at many maturities hit multi-year lows, prompting a wave of bottoming calls on Wall Street and Twitter, but current price structure predicts at least one more rally wave before the group settles down and tops out. That's bad news for equity investors who believe that the past three days of S&P 500 and Nasdaq gains signaled a tradeable low.

Bonds surged and yields fell after President Trump announced new China tariffs, set to go into effect on Sept. 1. China responded "in kind" by lowering the yuan fix, effectively dampening the financial impact of lost exports. Trump has responded by putting fresh pressure on the Federal Reserve and Chair Powell to cut rates, destabilizing the central bank's independence, which is intimately tied to bond prices. 

There has been a concerted effort to unleash optimistic sound bites each time the trade war kicks up a notch, in an obvious effort to buoy the financial markets, but investors have grown skeptical of the president's willingness to cut a deal. The 2020 election is less than 15 months away, and it's likely that he prefers enraged supporters heading to the polls, rather than satisfied folks checking off fulfilled policy objectives. This doesn't bode well for a China deal or higher bond yields.

TLT Weekly Chart (2008 – 2019)

Weekly chart showing the performance of the iShares 20+ Year Treasury Bond Fund ETF (TLT)

The iShares 20+ Year Treasury Bond Fund ETF (TLT) surged to a new high at $123 in December 2008 in the wake of the economic collapse, and it reversed sharply into 2009. The ETF relinquished the entire uptick in the following six months, finally settling at a two-year low in the upper $80s. The fund tested that level twice into 2011 and entered rally mode once again, reaching the prior high in the fourth quarter.

A 2012 breakout posted modest gains, topping out at $132, ahead of a downturn that ended with a higher long-term low in 2013. The fund completed a round trip into the prior high in 2015 and broke out once again, stalling at the rising highs trendline generated by the 2008 and 2012 highs. A steady uptick into 2016 suffered a similar fate, also reversing at the stubborn trendline, which has now lifted above $150.

The uptrend that started in 2018 looks just like prior rally waves, with the most vertical trajectory since the 2011 event. It reversed within 60 cents of a 100% retracement into the 2016 high on Wednesday after six days of higher-than-average volume, inducing many market watchers to pound the tables with topping calls. However, recent price action looks like prior occurrences, setting the stage for a breakout that reaches the trendline for the fifth time.

TLT Daily Chart (2018 – 2019)

Daily chart showing the share price performance of the iShares 20+ Year Treasury Bond Fund ETF (TLT)

Price structure since the November 2018 low has carved an Elliott five-wave pattern, with the fifth wave starting in July 2019. The first and fifth wave are now about the same size, offering a sound argument for an intermediate top. However, the fifth wave is grinding through a smaller-scale fourth wave after this week's reversal, predicting at least one more high before the rally set draws to a close. More importantly, the impressive fifth wave structure opens the door to an extension that matches the size of the third wave, lifting the fund into the trendline.

The on-balance volume (OBV) accumulation-distribution indicator lifted to an all-time high in June and has exceeded that level by a wide margin in the past two months. This bullish divergence predicts the fund will soon play catch-up and break out above the 2016 high. The vertical trajectory of buying power also raises the odds that the uptrend will eventually break trendline resistance and send bond traders and the world economy into unknown territory.

The Bottom Line

The long-term bond fund reversed this week after a powerful uptrend, but technical elements predict that it will soon break out above the 2016 high.

Disclosure: The author held no positions in the aforementioned securities or their derivatives at the time of publication.