The Indestructibles

The foundation of the bull market from 2009 to 2015 is bonds.  It is what allows the bloated stock buybacks, the lower interest expenses, and the capital gains which fuel the wealth effect.  The bond market is 1.5 times bigger than the US stock market yet gets less than 10% of the attention.  It was the main reason why 2015 was such a tough year for so many funds, not the weak energy market or a small loss in the stock market.

I remember seeing bonds in August 2015 hardly going up even though you had the scariest moment in stocks since 2011.  That confused me, but only later did I realize that a looming Fed interest rate hike and Chinese dumping Treasuries combined to put a lid on any bond rallies.

That bond market has completely disappeared.  The current bond market is the strongest I have seen it since 2012, and is doing the most bullish thing possible: going up strongly while stocks are going up.

With the likely lone Fed rate hike out of the way, and with future rate hikes extremely unlikely, you have gotten rid of a big barrier to higher bond prices.  The last big worry among bond investors was a Fed hiking cycle.  Well, that hiking cycle is over.  You have the mass media dumb money in fixed income still spewing the 2 rate hikes in 2016 Fed fed drivel.  That talk will be taken back quickly and conveniently when the market needs another boost higher later this year.

A lot of people will be surprised to see how high bonds go when the financial media finally catches up with what the smart money in fixed income is increasingly betting on:  a bull steepener with the belly of the curve, 5-7 years performing the strongest as Fed funds goes from pricing in a Fed rate hike in December to a rate cut in December.  All it will take is a little panic in China, and a pullback in the S&P to 1900.  That will be the trigger for a very bullish move in bonds as the BOJ and ECB panic and go even more negative with rates, and the Fed follows suit and calls off the rate hiking cycle and drops trial balloons about rate cuts and QE4.  In that scenario, I fully expect the Bunds to go -0.2% yield, and the 10 year yield to test all time lows at 1.38%.

These inter market relationships (stocks vs bonds, oil vs stocks, oil vs bonds, dollar index vs stocks) and how they change and evolve are clues to which markets are likely to go down and which ones are likely to go up in the coming months.  Right now, bonds > stocks > oil > gold > dollar.  But oil has been gaining strength recently, boosted by the OPEC expectations and seasonal demand.  That and the weak dollar should keep the S&P from dropping sharply.  But the one thing that acts strongest and feels indestructible are bonds.  Bonds should be much weaker here with stocks rallying so much but they refuse to go down.  Very much like 2012 and 2014.  I think that there will be one, and just one, good 20 bps rise in bond yields before we make an all out move towards the all time 10 year yield lows of 1.38%.  It should be within 4 weeks.  I want to be ready to buy when that happens.  More importantly, I want to make sure I hold it and ride the move as far as it takes me.

Nothing really good to trade right now.  Stocks have transitioned from bullish to neutral.  It will take a few weeks to transition from neutral to bearish.  The neutral phase is a tough one to trade, so I am just watching now.  Just waiting for opportunities to put on bearish positions (short stocks, oil, and long bonds).