Eoin Treacy's view At The Chart Seminar, we recommend delegates identify consistency characteristics by imagining they are describing the price action to a blind person. This allows us to develop an unvarnished perspective of what prices are actually doing. With this information we can then go on to plot a strategy and how an ending might eventually form. I thought that considering the important movements in the sovereign bonds markets recently it would be instructive to go through such an example using US 10-year Treasuries.

Blind Questioner: “Is the market in a major bull or bear market phase?”

Factual Interpreter: “The last major bull market in yields (bear market in prices ended in 1981 and yields have been in a secular bear market since (bull market in prices).”

Blind Questioner: “Is it trending or ranging?”

Factual Interpreter: “Yields collapsed from the peak between 1981 and 1986 and entered a rangy downtrend over the last 26 years. When we look at the log scale chart we see that the decline accelerated in 2008 and again in 2011. The yield halved on both occasions. This introduced more volatility than seen in the course of the prior 25 years. In tandem with this war between supply and demand real interest rates are negative since CPI is currently 2.7% and the 10-year yield is 2.15%.

Blind Questioner: “Since we are examining an interest bearing instrument would it not be more appropriate to deal with a total return index in order to get a more complete idea of what has motivated investors over such a long period?”

Factual Interpreter: “I agree, a total return index should offer some additional insights. If we examine the Merrill Lynch 10yr+ US Treasury Total Return Index we are presented with a well-defined view of the almost 30-year demand dominated environment for US Treasuries.”

Blind Questioner: “Is this chart trending or ranging?

Factual Interpreter: “The Index has been trending higher since its inception in 1983.”

Blind Questioner: “Is the trend consistent or inconsistent?”

Factual Interpreter: “It has been mostly consistent. There has been a series of quite lengthy ranges over the last 28 years but the broad upward bias has remained intact throughout.”

Blind Questioner: “What are the consistency characteristics?”

Factual Interpreter: “There is an unbroken progression of higher major reaction lows over the course of the 28-year uptrend.

“A series of higher rally highs is also evident.

“The Index has found support in the region of the 200-day MA on successive occasions.”

“Almost all of the major ranges have been posted one above another.”

Blind Questioner: “Tell me more about the ranges”

Factual Interpreter: There has been a rhythm to the way this trend has unfolded. An almost unbroken succession of medium-term ranges, one above another is evident since 1983.

Here is a table depicting the size and duration of the ranges.

“Without going into the minutiae of each of the ranges, what is now apparent is that while the ranges are not persisting for longer that ‘normal' they are becoming larger.”

“Relative to the previous 25-years this is an inconsistency.”

Blind Questioner: “How has the Index performed relative a trend mean such as the 200-day MA?”

Factual Interpreter: “Here is a chart of the Index's relationship to its 200-day MA. Overextensions of approximately 10% relative to the MA have been quite common over the course of the uptrend. This indicator also highlights the fact that the price often overshoots on reversions towards the mean. It would therefore be accurate to say that prices have tended to find support in the region of the MA rather than at the MA.”

Blind Questioner: “I now have a clear picture of the index's long-term consistency characteristics. You mentioned that the reactions have tended to become larger over the last few years. Can you tell me more about that?

Factual Interpreter: “During Q3 2008, the Index had been ranging in the region of the 200-day MA. In October 2008 it accelerated higher, reached a peak near 1660 and mostly ranged which allowed it unwind the overbought condition relative to the MA.

“It then broke upwards again in May 2010 and rallied to a peak near 1800. The subsequent unwinding of the overextension relative to the MA was quite sharp but prices again found support in the region of the 200-day MA.

“It broke upwards again in July 2011 and lost momentum from September.

“Despite the increased size of the reactions since 2009, they continue to reside one above another.

“The mostly rangebound environment of the last six months has at least partially unwound the overbought condition. A swifter pullback, such as that seen following a similar ranging phase in 2009 cannot be ruled out.”

Blind Questioner: “On a commonality basis, if we return to the price action of the underlying bond futures, how is the US 10-year Treasury future performing relative to other sovereign benchmarks?”

Factual Interpreter: Following a six-month ranging phase most are currently experiencing some weakness. The US 10-year Treasury price chart has broken downwards from its range. The Japanese 10-year has done the same. German, UK, Swiss, Canadian and Australian 10-year futures are also pulling back so there is a high degree of commonality in the sector at present.

Blind Questioner: Let me summarise. The primary consistency characteristics are that the market has been in a secular bull for the last 30 years. Yields have been declining but not in a particularly consistent fashion and two separate accelerations have occurred in the last few years. The total return index reflects a much clearer representation of the bull market with a progression of higher reaction lows, almost every medium-term range has formed above the last and the Index found support in the region of the 200-day MA on successive occasions. Overextensions relative to the 200d-ay MA of approximately 10% have been relatively frequent.

“What would now need to happen to question these broad consistency characteristics?”

Factual Interpreter: The total return index would need to fail to find support in the region of the MA, pull back into the previous medium-term range, encounter resistance in the region of the MA on the next rally and extend the decline to a new reaction low on a subsequent pullback. Each of these factors would represent deteriorating consistency for the uptrend and would form part of a developing downtrend.

Blind Questioner: What strategy would now be most appropriate?

Factual Interpreter: The most logical course of action would be to have a short position in Treasury futures. If history is any guide, the total return index is more likely than not to overshoot the MA, which suggests additional downside potential for Treasury prices. If the market subsequently continues to deteriorate one would be in the position of not having to chase. The risk is that today's breakdown from the six-month range fails and prices push back up into the range.