THIS JUST IN: You want to be long in a bull market. When a bull is running, stocks enjoy long tradable advances, not one-day jumps. Shares post gains in the triple digits, rather than the single digits, and they tend to move as a group. Think back to 1998 or 1999: It didn’t much matter which tech stock you bought — the majority of them went up and went up big. A rising tide lifts all boats. This is the nature of bull markets.
These days, the rising tide continues to be in bonds and other income-oriented instruments. We’ve been talking about bonds for quite a long time here, most recently in January. Although I admit that I’ve been repeating myself on this issue, I also know that this is the nature of bull markets: They move in trends, and trends often last a lot longer than most people expect.
The rise in bonds, and their continued outperformance relative to stocks, has been so dramatic that many market players are speculating that we’re in the midst of a bubble. But from my perspective, it’s not a bubble at all. It’s simply a bull market.
As we’ve been emphasizing for years, a big part of successful trading is avoiding the herd. And while bonds have exhibited strong price performance, I’ve yet to see any real evidence that the herd is running into fixed income.
First off, let’s remember that strong price performance doesn’t necessarily indicate big changes in herd mentality. Ask most people about bonds these days, and they’ll chalk up the strong performance to “safe haven” buying. Indeed, even on supposedly sophisticated business television, you hear the same shockingly ignorant analysis: that bonds are rallying simply because investors are scared and are seeking safety.
But as we pointed out last summer, many commentators are often quick to inaccurately interpret a market move as the result of some action of investors. The truth is, it can also be their inaction that’s ultimately responsible. Remember: The law of supply and demand is also the law of demand and supply. Often it’s not the presence of buying, but the absence of selling, that can make a market move higher.
The fact is, bonds are strong. Is it war fears? The slowing economy? Hedge funds caught short? Who knows. The point isn’t to understand why bonds are outperforming, but simply to know that they are outperforming. So instead of discounting the market’s strength, let’s study it.
A classic characteristic of a bubble is an explosion in both volume and public participation. One way to get a fix on both is to examine the activity in exchange-traded funds, the now ubiquitous mutual funds geared toward aggressive retail investors.
Just take a cursory look at the trading volume of the iShares bond ETFs. I first wrote about these products just after their launch last year, and I followed up by naming them as one of my “favorite things” last December. One indication that there’s no major bubble or public participation in these instruments is that despite continued price outperformance, their volumes remain well below that of your average midcap stock.
Indeed, if there’s irrational exuberance in bonds, you certainly aren’t seeing it show up in the fixed-income version of the QQQs (QQQ). According to Yahoo! Finance, the iShares Trust Lehman 20+ Year fund (TLT), which tracks long-term Treasurys, trades approximately 203,000 shares a day. Compare that with the QQQ, which still — even after three years of the worst bear market in history — averages more than 68 million shares a day.
Volume is one telling sign, public sentiment another. As painful as it might be on this anniversary of the Nasdaq’s all-time high, think back to the euphoria surrounding tech stocks in late 1999 and early 2000. The prevailing attitude at that time wasn’t fear, but greed. From cabbies to CEOs, people weren’t just talking about tech stocks — they were buying them by the truckload. Technology mutual funds couldn’t be opened fast enough, and Cisco (CSCO) became a household word. The returns weren’t just handsome — they were grotesque. In 1998, Amazon.com (AMZN) was up 966%, CMGI (CMGI) was up 605% and AOL (now AOL Time Warner (AOL)) was up 585%.
And this is precisely why I’m still betting on bonds. In the early stages of a real bull market, the prevailing attitude isn’t greed or even fear, but doubt. Gains are viewed as temporary events, chalked up as short covering, program trading, war fears…just about anything but the start of a legitimate bull run. And while the returns on bonds have been strong, they haven’t yet reached the mania stage implicit in an unsustainably speculative boom.
As we always like to point out, there’s never a substitute for proper trading technique. But when it comes to security selection, all signs are telling me that right now, the real bull market is still in bonds. And if the history of Nasdaq 5000 is any guide, this isn’t a bubble, but just the beginning.
– Originally on Mar 10, 2003 by Jonathan Hoenig
