Last week we looked at the shellacking that the municipal bond market suffered and I offered some reasons why that market was about to experience a reversal of fortunes. Today I wanted to talk about the much larger US Treasury bond market and argue in a similar vein that the bond market is also about to rally along side its municipal brethren.
There are several reasons why I believe this. One, the sentiment picture in the bond market looks very lopsided with most believing that we are about to see further losses. Given the decline we’ve already seen, this negative sentiment bodes well, from a contrarian viewpoint. As well, a simple but effective technical indicator is also signaling that we are about to see a trend change.
The Rydex Inverse Government Bond Fund allows retail traders to bet on declining Treasury bond prices (or a rising yield). Like other Rydex mutual funds it provides us with a good indicator of retail investor sentiment towards a sector. We’ve recently looked at similar indicators for the Energy Services sector and the Precious Metals sector as well.
In keeping with contrarian sentiment, we’d expect Rydex mutual fund investors to pile into a fund en masse when a clear trend establishes itself and then to reach a crescendo at the peak. Then, that money flow is unwound as the sector loses ground. This is exactly what we see happening in the Rydex (inverse) government bond fund:
The above shows the total assets of the fund (in millions) compared to the iShares 20+ Year Bond ETF (TLT). There is a clear inverse correlation. As retail investors chase recent returns, they balloon the total assets of the fund. And when they abandon this specialized fund, a major top is formed. They are almost consistently wrong at every major inflection point. And therefore, a great contrarian indicator.
Right now, the fund’s assets are $660 million, very close to the recent ‘ceiling’ of appx. $700 million marking major bottoms in TLT. In other words, this level of enthusiasm for this inverse fund means that the down trend in bond prices is either very close to or already finished.
Other sentiment measures are pointing to the same conclusion. For example, Consensus’ sentiment survey for Treasury bonds is down to 26% bullish. Historically, when we see so few bulls the bond market has rallied. Technically, I’d prefer to see the bullish percent get down to the low 20%’s but you can’t have all the stars align perfectly.
Another sentiment measure, the MarketVane Treasury Bond sentiment indicator is at 47%. That may seem to be middle of the road at first, but this indicator is best used relative to its most recent historical patterns. Taking those cues, the current level is just slightly above what is considered a bullish percent low, the low 40%’s; taking this close to a contrarian bullish sentiment.
As well, the recent Commitment of Trader’s report from the CFTC shows that small traders have by and large given up on their recent large net long position. Just a few months ago they were holding slightly more than 40,000 contracts net long. Now they are short slightly less than 20,000 contracts.
Finally, looking at the chart of the US 30 year Treasury Bond price, we can clearly see that the recent drop has been overdone. A simple but effective technical indicator is to compare the relative distance of price to its 50 day moving average. Right now, the 30 Year Treasury bond is appx. 5% below its 50 day moving average. This is a relatively rare occurrence and historically has marked a major bottom for bond prices.
Looking at the bond market via a chart of the yield for the 30 year Treasury bond we can see that it is approaching a strong and long standing resist zone in the 4.6%-4.8% range. The last time yields touched this ceiling was back in April 2010.
In summary, looking at the various sentiment and technical indicators, it is much more probable that the recent downtrend in Treasury bond prices has exhausted itself and will reverse. This will, of course, resume the very long term bull market in bond prices. Far too many bears have thrown themselves in front of this raging freight train and their mangled portfolios are not fun to look at.
As a technical trader I won’t wade into the myriad economic arguments for why the US or the US government is doomed, a failing empire, etc. The bearish case is always much more eloquent and usually far more alluring than the bullish case. Avoiding its siren call is not easy. But I’m going to stick with the indicators that have served me well and couple it with the use of judicious money management.