Wednesday, February 16, 2011

So Bad, They Are Actually Good

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

I haven't written an article about the Treasury bond market in a while, probably because it's been in a very strong downtrend without overwhelming negative sentiment to help turn the tide. That's all changing now.

Since the summer, Treasury bond prices have imploded 14%, and yields have exploded higher by roughly 38%. (Remember, in the bond market, price and yields go in opposite directions) Those are historically enormous moves in such a short period of time, especially since the Fed is supposed to be buying up all those bonds in hopes of keeping interest rates low to help the still crippled housing market

Just like with stocks, commodities and real estate, it's amazing how many people are positive near peaks and negative near bottoms. Market sentiment is usually polarized. So if 100% is the absolute highest number of bulls and 0% is the lowest number of bulls, you can certainly become very interested at extremes above 90% and below 10%.

Would you personally rather buy when almost everyone is bullish or no one is bullish?

Long time readers already know that I am very contrarian in my thinking. Of our nine investment strategies, the majority seek to buy weakness and sell strength, more commonly known in the industry as mean reversion.

Usually, when we are buying into some type of decline, the number of investors with a positive outlook on the investment falls substantially, hence the selling and someone to sell to us. And when we attempt to sell into strength, there are hopefully a vast majority of investors positive, hence all the buying to drive the security up and someone to buy from us. If it was only so easy!

Below is a weekly chart of the 30 year treasury bond. You can see the two times over the past two years when the number of bulls was at least 95%. While it didn't exactly pinpoint THE high, it was fairly close and the turnaround wasn't too far off. It takes a substantial rally to turn that many investors bullish and get their money invested. So who is left to buy?

You can see in both cases, treasury bonds fell very hard soon thereafter. During the second half of 2009 and early 2010, bonds stayed in a wide trading range that was supported three times by less than 10% of investors positive. Finally, a spark ignited the rally to suck in all that money and register 95%+ bulls at the right.
The chart below has been dialed down to a daily time frame and you can see the preponderance of bulls on the far left and subsequent (and current) powerful downtrend that brings us to today. Just earlier this week, the number of investors (actually futures traders) sank to under 10%. This does not mean that bonds must immediately rally. As we saw above, it can be the beginning of a trading range. But history does show that the downside should be limited and the risk/reward now favors the upside.

As I said on CNBC's The Call this past week, treasury bonds are the most unloved investment right now and something that deserves consideration for at least a trade. Maybe this is a major bottom or it's still out there after a rally. It's too early to say. Wouldn't it be interesting if treasury bonds saw a significant low just as Bernanke & Co. ended their purchases?

Feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC
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