Why I Remain Bullish On Bonds

	Bernie Schaeffer Schaeffers Research.com
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With the yield on the 10-year T-bill approaching four percent (again), I've received a number of questions on what I anticipate for the future of the bond market. While a bounce off the four-percent level is certainly not out of the question, I believe there is strong potential for a move below four percent, due to the enticing Expectational Analysis ^® recipe of strong price action coupled with universal bearish sentiment.

No matter where I look - futures, options, ETF transactions, economist predictions - the overwhelming consensus points to higher yields (or lower bond prices) for longer-duration bonds. In my mind, however, these bearish bets represent a reservoir of untapped buying power.

Bonds have lost the support of the big and little dogs, according to weekly data from the Commitments of Traders reports. Both the large speculators (non-commercial traders) and the small speculators (the proverbial "little guy") hold a net short position in the bond market. Commercial hedgers, or "smart money," remain net long, although this bias has been shrinking since late March.

Market pundits have been strikingly bearish on the bond market since early 2004, with consensus bearish readings of 93 percent or higher, according to Bloomberg surveys. In its latest monthly survey of 61 economists, conducted May 6, there was a unanimous consensus that yields will be higher six months from now. John Q. Investor is on board the bearish ship as well, as J.P. Morgan's latest survey of its clients revealed a record level of bearishness.

Continuing down the trail of pessimism, the iShares Lehman 20+ Treasury Bond Fund (TLT) is saddled with historically high short interest. While the number of shorted shares on this popular ETF has lately declined, the present short-interest ratio of 12.34 days to cover remains inarguably formidable. What's more, the short sellers may just have overextended themselves, as the total number of shorted TLT shares represents 230 percent of the measured available float for the fund.

Not to be left out, options players are building their pessimistic front, evidenced by the growing Schaeffer's put/call open interest ratio (SOIR) on TLT. History appears to have taught these speculative players nothing. In both the first and third quarters of 2004, a rising SOIR on TLT coincided with a rally in the fund. And I'm seeing the same pattern develop at the current juncture.

So pessimism is at or at least near an extreme, such that it's hard to imagine who might be left to take a bearish stance and exert some selling pressure. What supplements my bullish view on the Treasurys market, however, is the technical action in TLT, which has outperformed the S&P 500 since the March bottom. The fund is fresh from a bounce off support at its ascending 10-month moving average, which itself managed a bullish cross above the TLT's 20-month earlier this year.

In the shorter term, bond futures (US/) have mounted an impressive rally off their late-March low, gaining more than six percent.

This combination of solid price action and overwhelmingly bearish sentiment puts TLT in a contrarian sweet spot. In fact, the ETF has earned a Schaeffer's Equity Scorecard rating of 7.5 (on a scale from 0 to 10). (Keep in mind that the Scorecard ratings are figured slightly differently for ETFs, as analyst rankings are not included in the mix.)

I returned to the bullish camp on bonds on December 15, 2004, and I still feel confident in my rather unpopular stance. And I can't emphasize enough that a well-balanced portfolio, including some exposure to bonds and more than a little nested in cash, remains the most sensible alternative at this time given the risks in the equities market.

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