Bonds May Be Trying to Tell Us Something

 | Feb 26, 2014 | 5:00 PM EST  | Comments
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In 2013, traders made a small fortune being Treasury bears and equity market bulls. As a result, the retail public has been trained to assume there is easy money in these positions. However, markets move in cycles, and we are likely due for a change in the tide. After all, when certain ideas and positions become comfortable, it is a sure sign that they shouldn't be. Warren Buffett once said, "Be fearful when others are greedy, and greedy when others are fearful." 

The Treasury market has held up remarkably well in the face of higher equity prices. In overly simplistic theory, as investors move money into stocks, they "should" be removing funds from safe haven investments such as government-backed bonds and notes. Nevertheless, Treasury prices have not behaved in the manner history might suggest.

The S&P 500's rally, spanning about 120 points, has resulted in only moderately lower Treasury prices. In our view, the willingness of investors to allocate money to Treasuries while stock prices march higher is a signal that there is some underlying anxiety in the financial markets. Perhaps new all-time-highs in the stock indices are more indicative of a last hurrah than of a new normal, and perhaps the bond market is trying to tell us that.

We delved further into this idea via the Commodity Trading Commission's Commitments of Traders Report. Within the stats, we noticed that while the small speculators were amassing rather large net short positions in the 10-year note and bullish bets on the e-mini S&P 500 index, the large speculators were gradually doing the opposite. Although it isn't always the case, the large speculators tend to have a better track record than the small speculators. Accordingly, we'd prefer to side with the so-called smart money (this time anyway).

Further, large speculators are currently holding meager short positions in the S&P 500 and appear to be in the beginning stages of converting bearish 10-year note trades into bullish. Consequently, there is certainly room for them to add to positions which could eventually convert these glimmers of guidance into full-fledged trends. You might not be willing to be a Treasury bull, but you should at least be mindful that this is not an ideal environment to be overly bullish on the equity markets.

It is difficult for most people to fathom the idea of Treasuries moving higher and, therefore, yields lower, but that is the scenario that investors should be preparing for. Simply put, if money is flowing into Treasuries while equities are near all-time-highs, what will happen if we actually see money flow out of stocks?

 

TLT
QST/Barchart.com

 

 

ZN
QST/Barchart.com

 

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