Within Tier 1, the real-money portfolio I manage for The Motley Fool, I like to use a concept known as time arbitrage to my advantage. It has helped me earn a 128.93% return since Tier 1 was launched on Sept. 1, 2011, beating the S&P 500 by more than 40 percentage points over that time. Today, I believe I've found another time arbitrage opportunity in the iShares 20+ Year Treasury Bond (TLT 0.03%) ETF.
My colleague Morgan Housel recently described time arbitrage as "being patient enough to exploit the gap between your investing horizon and someone else's." I've used time arbitrage to purchase shares of outstanding businesses such as Whole Foods Market (WFM) and LinkedIn (LNKD.DL) at bargain prices. But, as can be inferred by Morgan's definition, the concept can be applied beyond just stocks.
With the iShares 20+ Year Treasury Bond ETF, my focus is on the opportunity currently presented in the U.S. Treasury bond market. Mainly, I believe the price of this ETF is set to fall dramatically in the years ahead. That's due to the relationship bond prices have with interest rates: as rates rise, bond prices fall.
As I noted in my initial short TLT recommendation, it's entirely possible that, even after an epic three-decade bull market in bonds, more upside for Treasury bonds might still lie ahead:
The global economy is being affected by slowing growth in China, political turmoil in Europe, and plunging oil prices that some believe portend even more trouble ahead. If we enter a deflationary environment, then bonds can be exactly what you do want to own, as their prices would likely rise as investors fled to "safe-haven" investments. And few investments are considered safer than U.S. government treasury securities.
All of that remains true today.
However, I also wrote that, "looking further ahead, I find it unlikely that rates here in the U.S. will remain at such low levels. The Federal Reserve has already ended its massive quantitative easing program, and it has hinted at rate increases in the near future."
Therein lies our time arbitrage opportunity.
In addition, since the time I initiated Tier 1's short position in the TLT, events have unfolded that I believe make it more likely the Federal Reserve will raise rates in the coming months.
Much was made about the removal of the word "patient" from the Fed's latest policy statement in regards to raising rates, but even more interesting was the Federal Open Market Committee's statement that "further improvement in the labor market" will be a key determinant of the timing of rate increases.
That's because labor market data has been largely positive in recent weeks. The February jobs report showed employers added 295,000 jobs, exceeding the 240,000 forecast from economists surveyed by The Wall Street Journal. That led to a sharp sell-off in bonds as traders took the news as a signal that the Fed could begin raising rates as early as June.
While rates have drifted back down since the February jobs report was released, and even as the Fed has since downgraded its views on the economy and lowered its forecast for the federal funds rate at the end of 2015, continued strength in the labor market will make it more likely that the central bank will raise rates, and potentially sooner than many market prognosticators -- and even the Fed itself -- predict.
But it doesn't matter to me whether the Fed raises rates in June, or September, or even next September. I'm not a trader; I'm a long-term investor with a multiyear investment horizon. So my focus is on the extended trajectory of interest rates -- and the corresponding decrease in Treasury bond prices. I believe the long-term trend in rates will be higher as monetary policy returns to more normal levels and the economic recovery in the U.S. continues. Some Fed officials appear to share that view, too.
So while Wall Street and many traders are focused on the next few months, I -- and Fools like me -- can invest based upon how we see the world in the years and even decades ahead. That's time arbitrage, and it's one of the most powerful advantages we have as individual investors.
My strategy to profit from this situation is to increase Tier 1's short position in the iShares 20+ Year Treasury Bond ETF. I expect the price of this ETF to fall over time along with bond prices as U.S. interest rates once again ascend. Therefore, at least 24 hours after this article is published -- standard operating procedure for The Motley Fool's Real-Money Stock Picks program that is designed to give Fools the opportunity to buy ahead of us should they so choose -- I will be shorting the iShares 20+ Year Treasury Bond ETF in my real-money portfolio.