As I’m sure you’ve seen, it is a wild day in the market, with the doubly bearish combination of higher interest rates and disappointing earnings hurting the market. While our Cisco (CSCO) position is down today, which we’ll talk more about in a moment, it is being more than compensated for by the increase in both the iPath S&P 500 VIX Short Term Futures (VXX, up about 3.5% as I write this) and ProShares UltraShort QQQ (QID, up about 3% at the moment).

Today’s action gives us a good opportunity because I do not expect to see both a lower market and higher interest rates much longer. I say this because the Fed will be more than willing to continue its quantitative easing (QE) program if the market remains weak. In addition, lackluster retail sales, declines in mortgage applications, disappointing Empire Manufacturing and Philly Fed indexes and Cisco layoffs announced last night could all make the Fed more willing to continue its $85 billion a month in asset purchases.<

New Position: iShares Barclay 20+ Year Treasury Bond (TLT)
Type: ETF
Allocation: 12%
Strategy to Open: Buy up to $104.50

This dynamic gives us an opportunity to play rising bond prices and, correspondingly, lower yields. (Remember, bond prices and yields move opposite one another. The higher the price for the bond, the lower the yield.) The instrument to do this is the iShares Barclay 20+ Treasury Bond (TLT) ETF, which moves in correlation with the prices of long-term U.S. Treasury bonds (more than 20 years) on a daily basis.

This new position is almost the exact opposite of ProShares UltraShort 20% Treasury (TBT), which we sold yesterday, and builds on that same thesis. The main difference is that it is not a leveraged ETF. As we talked about, I believe Treasuries are already discounting some tapering from the Fed. Considering the recent data I just mentioned that show some economic concerns, the tapering talk could well subside temporarily. If that were to happen, and if that talk is cut back, the 30-year Treasury yields could easily decline to 3.5% from 3.8% currently. Such a move would result in a quick gain in TLT probably somewhere in the 7%–8% range.

As we also talked about, bond prices could be due for a short-term increase in this increasingly choppy market, as the long-term Treasuries could again become viewed as a “safe haven.” A temporary flare up in the European debt situation following the German election could also cause investors to shift to the perceived safety of bonds.

In addition to the upside catalysts, I like the risk/reward characteristics of TLT right now because we’re well hedged if rates surprise us and rise a bit. Any losses in TLT would be more than compensated for by further declines in our bearish positions.

Buy TLT up to $104.50 and make it a 12% position in your portfolio. (I will be buying approximately 115 shares worth about $12,000 for my portfolio.) As I said, this is not a leveraged ETF (I did look at a few, but liquidity was insufficient), so I want us to up our allocation given a high degree of confidence and the favorable risk-reward characteristics. This could be a quick mover, and I will be watching closely and get in touch with you whenever we need to take action.

A Note on CSCO and Other Positions

I also want to talk briefly about CSCO, but let me first comment on our other bearish positions. They’re obviously up today, and I want to continue to hold them at this moment. You might naturally think a decline in tapering talk would help the market, but I see the risk of a worse economy exceeding that of higher rates, given the declines in mortgage applications, along with the risk that the slow retail sales could spread to autos, which have been a stalwart this year. This would pressure the tech sector and increase volatility, so continue to hold QID and VXX for now.

On CSCO, the stock is down more than 7% today after announcing layoffs and lower growth projections. The broader market action is amplifying CSCO’s weakness, and today’s selling is an overreaction to the news. Lowering projected sales growth to 3%–5% from previous expectations of 5% is not worth a 7% haircut to CSCO at its current valuation. CSCO sells at similar multiples now to tech megacaps AAPL, INTC and MSFT, and is not likely to face the pressures on its business model that those companies will going forward. We’re still up more than 4% in the stock, and I do look for it to bounce, so continue to hold CSCO for now.