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 Paul@investfortomorrow.com.



Until next time…


Paul Schatz

Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/
Follow us on Facebook at www.facebook.com/heritagecapital and on Twitter @Paul_Schatz

Stock Market Getting Tired But Higher Prices Still Lie Ahead

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

In early February I contributed a piece here entitled, Bottoming Process Continues, where I made the case that stocks had either just bottomed or were about to, and that would lead to another strong run to new 2010 highs. I wrote similar articles in my newsletter, Hang in Bulls... Bears Almost Done that was followed up with Bottoming Process Continues Building. After forecasting a 4-7% pullback in January (we saw 8.5%), I was very confident that the decline was close to ending and a new leg higher would ensue, carrying the major averages above their 2010 highs on the way to Dow 11,500 - 13,000 when the weather turned warm.

Although rare, it's always nice when the market perfectly cooperates with your thought process and even nicer when your clients are the beneficiaries! So here we are, back at the highs and everything looks mighty rosy again, right? Well... kinda, sorta.

My forecast for the Dow remains in play sometime between Memorial Day and Labor Day, but the very short-term is a bit cloudy with the worst volume pattern since the bull run began. Volume is so important as it is the horsepower of the market’s engine. The stock market can fall and fall on light volume, but sustainable rallies have always required increasing volume. Stocks have rallied in almost straight line fashion, but are in need of a quick pause to refresh. My favorite analogy is that of the great steakhouse dinner.

Between the appetizer, salad, steak, various sides, wine and dessert, you can barely stand at the end of the meal. And before it's time for your next feast, you must digest the food. Markets work in similar ways. After a big rally, the market has to digest to make room for the next meal. The bigger the rally, the longer the digestion. In the current case, all the market needs is a good, short-term cleansing before it's ready to eat again.

I imagine that whatever weakness we are going to see should be right ahead of us. How long it lasts and how deep it goes are questions that will be answered along the way. In the most bullish case, we'll see a few nasty down days that look and feel really bad, but end quickly. But if investors don't increase their level of worry and don't become more concerned after a few days like that, we'll probably see a deeper and longer pullback. The first level I am watching is 1120 - 1125 on the S&P 500 and 10,300 - 10,400 on the Dow.

Should this pullback materialize, and it rebuilds a little worry in the market, I think it can be bought with both hands for another move to new 2010 highs during the second quarter. As I've mentioned before, one of the most important things to watch is sector and index leadership. Before any "real" correction (10-20%) sets up, there should be some clues here from what's leading and lagging.

Over the past year, with all the cheap and easy government money being thrown around, the financial markets have done nothing seriously wrong to jeopardize the bull run. But with Bernanke & Co. already beginning to pull the punch bowl by ending their trillion dollar purchase of mortgage backed securities and the Obama administration raising taxes in 2011 by letting the Bush tax cuts expire, the markets are much closer to another problem later this year and into 2011.

Please feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC
http://www.InvestForTomorrow.com