Pent Up Demand

The release of pent up demand in the bond market has been explosive since the March FOMC meeting.  From election day in November till the March FOMC meeting, allocations to the bond market were either moved to cash or the stock market.  You have to remember that since 2008, most of the inflows into financial assets have been to bonds, not stocks.  This is a secular trend that will last for many years, as the developed world population ages, and goes towards less risky assets.  It doesn't hurt that you have had massive QE in the US followed by Japan and Europe.

People don't want to stay in cash for long, they need to get longer in duration and down in credit quality to get yield.  That is why corporate bonds are so popular, because it provides extra yield without having to take bigger risks as with equities.  All that demand that was postponed because of fears of massive tax cuts and infrastructure spending have been for naught.  Now that bond investors feel less fearful of a big rise in interest rates, they are piling back into bonds.

I have not been bullish enough on bonds this year, although I did manage to capture much of the move higher from March to April.  I missed the second wave higher in May/June.  The though process was simple.  I didn't think stocks would go down much, if at all, and would likely grind higher or be range bound in a tight range, at worst.  Therefore, the upside in bonds would be limited and since bonds were overbought, I thought it would give me another opportunity to buy at lower prices.  But bonds started to go up with stocks in late May and early June, and the plan went awry.

This little episode over the past month was a big missed opportunity.  Also there was a  sudden surge in the number of speculators getting long 10 year Treasury notes, and I viewed that as a contrarian signal.  It is a contrarian signal only if the market itself is not in the middle of a strong trend.  When in the middle of a strong trend, the market will go where it needs to go, with or without speculators along for the ride.  Right now, bonds are in the middle of a strong trend higher.

One can come up with reasons, such as underperforming economic data or the dissipation of the Trump trade, but the main underlying reason is the demand for fixed income at this time and at these levels.  It reminds me to never lose sight of the big picture when trading.  You want to put on trades that you are comfortable holding long term, not just short term.  It helps to avoid trying to capture every little squiggle, even those opposite of your long term outlook.

We have an FOMC meeting today, it should be a boring one.  The Fed is still not in a position to be overtly dovish because of the strength in the stock market.  But that is the direction they will be heading towards, because their dot plots for 5 more rate hikes till the end of 2018 is grossly misaligned with the pricing in short term interest rates markets.  And just like 2016, I expect them to come back towards the market's point of view, which means they will have to talk more dovish going forward.

I am getting more interested in shorting the S&P now that we've retraced the down move from Friday.  Usually opex week during a futures expiration month is bullish for stocks, so I will wait to see what Yellen says, and will hope that there is a pop higher which I can short with confidence.  I will be leaning short for the rest of the month as long as we are above 2420.  A move to 2400 is probably right around the corner.