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/
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Stocks Could Be Shaky Heading In To January

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


Last week, I wrote about some of the year-end tricks, games and trends that we often see in the stock market. One of them, the January Effect, where the most beaten down stocks that make new 52-week lows during the fourth quarter tend to rise from mid December to early January as tax loss selling abates. Look at stocks like COGT, GMXR, PCS and SQNM as examples that worked this so far this year. But similar to 2003 when the market made its low early in the year, the overall trend is somewhat muted to date and there are still dozens of January Effect candidates waiting to make their move.

The last week of the year predictably saw anemic volume as so many traders and portfolio managers took time off and closed their books early. Overall volume hasn’t been strong for several months, but that should change beginning next week when everyone wipes the slate clean and comes back to work at point zero.

Heading into the New Year, we have some interesting crosscurrents that should resolve themselves in early to mid January. On the plus side, the major indices closed the year near their highs for 2009, so momentum is in the bulls’ favor. On the negative side of the ledger, sentiment has become very bullish, which usually precedes a market pullback or flat out correction. Two major sentiment surveys from Investors Intelligence and American Association of Individual Investors are showing more bulls now that we’ve seen in a very long time. So many bulls is a negative since the market often confounds the masses at extremes and by being bullish, it usually means an investor has already committed funds to the stock market. As I’ve mentioned before, this is called a contrary indicator.

Adding fuel to that fire are the options traders who are exhibiting very bullish behavior. These usually wrong folks at extremes have pushed the put/call ratios (ratio of options volume) to warning levels usually seen at short to intermediate-term market peaks. Given that the last rally occurred on such light volume, I would have to give the nod to the bears as we come into January. It will be interesting to see what happens after the third trading day as investors begin to settle in and position themselves.

Finally, it was a very disappointing last five trading days of the year for the bulls. The trend called for strength, but this year was rather quiet with only the Nasdaq 100 showing just a fractional gain. Given that, the next trend calls for the S&P 500 to outperform the Nasdaq 100 during the first five days of the New Year with the Russell 2000 (small caps) and S&P 400 (mid caps) to also show some outperformance next week. These are trades I look forward to executing each year since there’s not much debate as to when to initiate and exit, and the winning percentage has been strong.

Let me take this opportunity to wish you a very Happy, Healthy, Safe and Prosperous New Year! May the world find peace and you have the best year of your life!!

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

Until next time…

Paul Schatz