Mark Hulbert: Bond Prices Still Have Upside

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At least according to the current readings of his Hulbert Bond Newsletter Sentiment Index (HBNSI):
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Expecting the unexpected

By Mark Hulbert, MarketWatch
Last Update: 12:01 AM ET May 18, 2005

ANNANDALE, Va. (MarketWatch) -- Hardly anyone expected the bond market to be as strong as it has been over the last six weeks.

Which is why we should have expected it.

The markets rarely accommodate the majority, especially one that was as nearly unanimous as the one in early April that held that rates had nowhere to go but up.

Consider the all-time low to which the Hulbert Bond Newsletter Sentiment Index (HBNSI) dropped in early April. This index reflects the average bond market exposure among a subset of bond market timing newsletters monitored by the Hulbert Financial Digest.

On April 5, the HBNSI dropped to minus 67.4 percent, which meant that the average bond timing newsletter was recommending that two-thirds of assets allocated to the bond market be invested on the short side of the bond market. This was more than 10 percentage points lower than the record low from prior years, and represented extreme certainty that interest rates would be going up.

As we now know, of course, rates have instead declined markedly, pushing bonds significantly higher.

The (TYX: news, chart, profile) CBOE's 30-year Treasury Yield index has declined from 4.75% on April 5 to 4.47% at Tuesday's close. The (TNX: news, chart, profile) CBOE's 10-year Treasury Yield index has declined over this same period from 4.47% to 4.12%.

As the editors of the Wall Street Winners newsletter noted earlier this week, Treasury yields are now back down to "pre conundrum levels." They were referring to Federal Reserve Chairman Alan Greenspan's comment earlier this year that the decline among bonds with longer maturities represented a "conundrum," since the long yield almost always rises during periods of central bank tightening.

But from a contrarian point of view, there was - and is - no conundrum. Bull markets like to climb a wall of worry, and this appears to be precisely what has happened.

It's worth noting that the wall of worry in the bond market has been around for a lot longer than just the last six weeks. For example, the HBNSI dropped to what at the time was a record low of minus 56.3 percent in late July and early August of 2003. That was when the bond market underwent a mini-crash, with rates rising quickly from the 40-years lows of early July.

As I wrote on a number of occasions during the summer and fall of 2003, this extreme bearishness among bond market timers made it unlikely that the bond market's break was the beginning of a major bear market. Sure enough, the CBOE's 30 Year Treasury Yield index has dropped a full percentage point since then, while the CBOE's 10 Year Treasury Yield index has dropped nearly half a percentage point.

What are the bond timers saying today? Believe it or not, they on balance are still bearish. And that means that the sentiment picture is still bullish.

To be sure, the HBNSI is not as low as where it stood in early April, so the sentiment foundation of a bond rally isn't as strong today as it was six weeks ago. But the HBNSI still is in negative territory: As of Tuesday night's close, for example, it stood at minus 14.7 percent.

What's it all mean for the rest of the financial markets?

Winning the understatement of the year contest, the Wall Street Winners editors say, simply, "something is amiss."