How Much More Do Rates Have To Fall?

There were a lot of reasons why we've been so bullish of Bonds. One of them was because of the positioning of Commercial Hedgers and Speculators in the Futures market. Commercial Hedgers, the "smart money", had on their largest net long position of all time going into the 4th quarter. We had the choice to either fight them or join them? We happily joined them for the mean reversion.

Another reason we felt bonds would go higher was because we were so bearish of Stocks. We've been advocating for large cash positions for months (see here and here). The higher bond trade made sense with lower stock prices. This is a good example of how the intermarket analysis we include in our process helps us put the pieces of the puzzle together. If you check my profile on Twitter, I explain exactly what I do.

This week we made new 52-week week lows in the S&P500 relative to both Gold and US Treasury Bonds. When assets are in downtrends, they tend to go down on an absolute basis and also relative to their alternatives. Stocks, in case you hadn't noticed, are in a downtrend. Bonds, as they make 10-month highs are in an uptrend. You can bet that the trends here will change and stocks will magically reverse and start heading higher, and bonds will miraculously roll over. That absolutely could happen.....

But as we all know, "hope" is not a strategy. We need to manage risk responsibly and allocate assets where we stand to make money, not lose it. By definition, markets trend. That's where the efficient market morons get it wrong. Stocks have cycles where they go up for a long time, and then they have cycles where they go down. We don't have to catch the top or the bottoms, although it does happen sometimes. Our goal is to just catch the middle chunk. That helps us stay in trends, instead of bailing for no reason like many people did in stocks over the past 2 years.

My bet is that bonds continue higher. If we're above 103 in $IEF, I see no reason not to be aggressively long of bonds. Whether you're in futures, ETFs, options is up to your time horizon, risk tolerance and overall objectives. But the line in the sand here moving forward is well-defined in $IEF. The next target is up near 105.30:

Here's what 10's look like. I've said consistently that if we lost 3% in the 10-year yield, we could be in for a massive drop in rates and that's exactly what we've seen. If we're below 2.80%, I think we need to be aggressively long of bonds. 2.50% is the next downside target and where we want to be taking profits on all tactical bond trades. It would take $IEF below 103 and the 10-year above 2.8% to invalidate any of these developments.

So if we're right in bonds, what are stocks likely to do in that environment? I'd argue they continue to go lower.

There are a lot of bag holders out there that don't read my research and are still fully loaded in their portfolios. They are not prepared for a 50% decline in stocks, or even worse. Humans behave in the exact opposite way that they should when stress levels are elevated (money is involved). They want to be greedy when they should be fearful (this October). They become scared when they should be greedy (hopefully this first quarter).

These investors that have been left holding the bag, whether it's their own lack of risk management procedures, poor discipline or just bad advice from their advisors, are not sitting pretty right now. They are seeing themselves up for disaster. They're going to puke out their portfolio holdings on one of the upcoming flushes in the market and then, to make things worse, they won't get back in. They will be forced to chase stocks later down the road and we'll happily be selling to them. These are the alpha creators and we're thankful for them.

Are you one of these bag holders? Are you still 100% invested in the stock market? Do you not have any risk management procedures in place? Are you just here "hoping" that stocks start going up?

If you're in this category of irresponsible market participants, the rest of us would like to personally thank you for your donations. We hope you get crushed this quarter.

Happy New Year!

JC

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