Bonds as a contrary indicator

The first week of March has been fairly uneventful for equity markets, unlike some other weeks this year. What has been noticeable is the apparent change in the sector momentum; one example has been the recovery in the mining sector so far this year.

 

On Thursday the likes of Aberdeen Asset rose, a truly unloved stock having fallen 40% in the past year. Anglo continued its recent recovery, as did BHP Billiton. Barclays rallied from the troubles created by its earnings release a few days ago. House builders, now a darling for fund managers, were down, as were tobacco and pharmaceutical stocks. Whether this change signifies a change in sentiment towards economic growth, as fund managers appear to be rebalancing to a more cyclical bias, time will tell.

 

Economics and Psychology, as we have mentioned in the past, are becoming more intertwined. Daniel Kahneman, a psychologist, won the Nobel Prize for economics. A wealth management conference this day worth its salt is not complete without a lecture on human behavior, and relating it back to investment decisions.

 

On this blog we often talk about sentiment indicators, the AAII sentiment index for retail investors many use as contrarian guide. The ratio between buyers of put and call options is another, the Vix index another.  In current conditions and contrary to what one would imagine, one could add in the ten-year US treasury market.

 

Bond yields fall when prices rise, investors buy bonds as a defensive measure as fear increases. In good times, investors sell bonds to invest in riskier assets and yields rise. The equity market in February 2016 bounced as yields bottomed out. One could argue fear reached its peak. In October 2013 the equity market rallied post the “ flash crash” in bond yields. Bond yields rose in late 2013 and equities fell in January 2014.

 

From October 2014 ten-year treasury yields have traded between 2.4% and 1.7%. In the same period of time the S&P 500 has traded between 1850 and 2100. During that period, the selloff in equity markets has correlated with yields having peaked around 2.3%, and it has been time to buy equities when yields have fallen to 1.7%.

 

Equity market falls coincide traditionally with the peak in bond yields. High longer dated US treasury yields should signify optimism on economic growth going forward. The peak in the equity market in 2000 coincided with the peak in bond yields. 

Posted on March 3, 2016 .