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Where's the Crowd\?

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Since January 2000, there's been one heck of a bull market in a certain asset class. Obviously, it hasn't been in stocks. The asset class I'm referring to, of course, is bonds. Stocks have been sold with reckless abandon for more than a year (Read: Bear Market) and inflation has been a non-issue. That environment has made for one heck of a run in bonds. The following weekly chart of the 30-Year Treasury Yield (TYX.X) clearly displays the bull market in bonds. (Remember: Bond prices move inverse to yield; yields decline, price advances.)

(There's a lot of esoteric stuff that we could delve into concerning bonds. But I don't want to do that. Instead, let's keep this simple. For our intent and purpose just keep in mind that if bonds are rallying (yields falling), the capital to purchase bonds has to come from somewhere. And recently, the capital to buy bonds has been coming from the proceeds of selling stocks. That dynamic is subject to change, but for now, bonds are moving inverse to stocks.)

The bull market in bonds and bear market in stocks has caused an interesting shift in investor psychology over the last year. Glancing over the myriad mutual fund categories over the weekend, I noticed that with the exception of small cap stocks and precious metals funds, the only categories doing well this year are anything bond-related. In fact, just last week, $6 billion flowed from equity mutual funds and $4 billion of that capital moved into bond funds. Moreover, the financial media has been propagating the allure of bonds recently. It would seem that after years of being conditioned to lofty stock returns, investors are finally warming up to the idea of bonds. But that could be an unfortunate mistake for many.

It's well accepted that the crowd is generally wrong. And when too many market participants enter into a particular market on the same side, it generally signals that the prevailing trend is about to reverse. Again, there's a lot of esoteric psychological and sociological stuff that we could get involved in with this premise. But let's remain simple: The crowd is generally wrong.

Up until Tuesday morning, the crowd appeared to be buying bonds and selling stocks. But a little friendly economic data shifted that dynamic, at least for Tuesday. The sell-off in bonds Tuesday is one of the sharpest in recent history, as displayed by the daily chart of the 30-Year below. Furthermore, I don't think the sell-off in bonds is inflation-related judging by the decline in precious metals.

So I'm wondering: While the crowd and those late to the game are buying bonds, is smart money in the bond market beginning to take their profits and rotate into stocks ahead of any forthcoming economic recovery?

Bullish stock traders keen to the bond market might watch for the 30-Year Yield to break above 55.50, or 5.55%. If the 30-Year trades through that level this week, I think that stocks could have significant room to the upside.

Eric Utley
Contrarian
Option Investor

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