A 2011 Rebound in the Bond Market

by: Larry MacDonald

As I noted in a December 16 post, bond yields have blasted off the launch pad. They have since slipped back but nevertheless remain elevated: the yield on the 10-year U.S. Treasury note closed at 3.35% Wednesday versus 3.5% a week ago. By contrast, the yield was 2.4% on October 8.

The post noted that bond king Bill Gross of PIMCO had switched millions of his own money into bonds the day before. In the following days, I’ve come across more signals that support the view long-bond yields are more likely to go back down than up.

1. The Globe and Mail’s Ian McGugan drew attention to the relatively large weights for 30-year U.S. Treasuries in the portfolios of Perennial Asset Management Corp. President Murray Belzberg doesn’t think quantitative easing will ignite inflation, or even a vigorous economic rally. He sees 30-year yields, now around 4.5%, falling back a full percentage point to the levels of late August, before hints of QE2 emerged.

If that happens, the price of 30-year Treasury bonds will appreciate nearly 20% (bond prices and yields are inversely related). And that should be a better return than the stock market in 2011, Belzberg says. Stocks have gone up a lot in the past few months and his view is that economic growth isn’t going to be great enough to support Mr. Market’s expectations .

2. Another commentator, Donald Dony of the Technical Speculator advisory, noted last week that Relative Strength Index (RSI) readings for 10-year Treasuries were flirting with the 70 level that historically signals a retracement in yields and pullback in stocks. As RSI is a technical indicator that measures the strength of momentum using the ratio of higher to lower closes (so stocks with more or stronger positive changes have a higher RSI), the message is that upward momentum in bond yields is close to an unsustainable extreme.

Dony believes the turning point will come within the first 3 months of 2011. Going by the past record, there will be a correction in the S&P 500 by about 8% and rebound in the bond market.

Disclosure: None