Opinion: Bond market bullishness is at a record, a worrying sign
Investors fear a possible economic recession and negative U.S. interest rates
CHAPEL HILL, N.C. (MarketWatch) — Contrarians in the bond market aren't simply walking for the exits — they're sprinting.
That's because bond bullishness today is higher than it's even been — or at least since the 1980s, when I began monitoring the investment-newsletter industry. To bet on higher bond prices today, you in effect have to bet that this overwhelming consensus will get it right. That's just the opposite of what contrarian analysis teaches us is most likely.
Consider the average recommended bond-market-exposure level among a subset of short-term bond-market timers (as measured by the Hulbert Bond Newsletter Sentiment Index, or HBNSI). Earlier this week this average soared to 74.7%, a record at least since the mid-1980s, more than 30 years ago.
Not only is the HBNSI at an all-time high. Another source of contrarian concern is how quickly it has jumped. As recently as a month ago, for example, it was minus 11.8%. (See the chart at the top of this column.) In other words, there has been a veritable stampede to jump on the bullish bandwagon.
There's yet more reason to be worried: The bond timers have had precious few external reasons for turning bullish. I say this because the usual pattern is for bullishness to rise and fall more or less in lockstep with the market. This has not been the case over the past month.
The CBOE's 10-year Treasury Note Yield Index TNX, +0.34% for example, stands today at almost precisely where it was at the beginning of March. So we would otherwise expect the HBNSI to also be at more or less the same level — not 87 percentage points higher.
To be sure, it's difficult in the face of so much bullishness to imagine what will cause a major bear market in bonds. Wall Street appears instead to be more concerned about a possible economic recession and the possibility of negative interest rates.
But contrarians quickly point out that it's always this way at market tops. By definition, the news is more rosy and optimistic when the market is topping than when it's climbing the so-called wall of worry that is the characteristic sentiment feature of bull markets.
Might contrarian analysis get it wrong? Of course. This is always worth remembering about any forecasting model, but especially right now. That's because the Federal Reserve's low-interest-rate policy has rendered contrarian analysis less effective in the bond market over the past decade than it otherwise would have been.
Indeed, as you can see from the chart above, there have been occasions in recent years in which interest rates have fallen (and the bond market has therefore rallied) in the face of higher-than-average levels of bullishness.
But these periods have been the exception rather than the rule. Even with its reduced level of effectiveness, it's still been the case in recent years that higher levels of bullishness have more often than not been followed by bond market declines.
Bond bulls should take note.
Posted by: sarah_oz@yahoo.com
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