Who’s Selling Bonds?

Yields on 10-Year U.S. Treasury bonds sunk to an all-time low of 1.37% on July 5th, yet so far there’s been a mysterious absence of contrarians willing to step up to say that “the” secular low in bond yields is at hand. Evidently, strategists and economists have learned the painful lesson of the “widow-maker” trade (shorting Japanese government bonds).

While there are few public bond bears, we’ve watched with interest in recent months as “commercial hedgers” in Treasury bond futures have steadily built up a sizable short position. By late June, their net short position reached 109,000 contracts—the largest short bet since the LTCM crisis in October 1998. The timing of that huge short ultimately proved terrific: yields shot up by 240 basis points, to 6.80% over the next 15 months, during the most frenzied stage of the Tech bubble.

Note that commercial hedgers also held a large short position at the summer 2012 trough in yields (and the previous record low), while their largest long positions in the last 20 years coincided with the last two opportunities to lock in bond yields of 5% or better.

  • The commercials’ timing record is far from perfect, but their positioning at major bond market inflection points has been good enough that we should pay attention—especially when their caution occurs in the midst of a public obsession with the steady income offered by bonds and bond-like stocks.

  • Imagine the probable portfolio hit if yields were to revert merely to year-end levels (2.27%). If that thought proves too painful, liquidate some dividend stocks.

© 2016 The Leuthold Group

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