Bonds Indicate Liquidity Is Plentiful

| About: iShares 7-10 (IEF)

May of 2012 has definitely proved to be tricky for investors. Many eurozone issues, which were passed over in North American markets by the strength in Apple (NASDAQ:AAPL), came to the front stage without warning. Investors were definitely caught off-guard as the Bernanke and Draghi put did not seem to work anymore.

However, it is important to differentiate between the corrections in the market caused by uncertainty and profit taking and the ones which result from a liquidity shortage. The liquidity crises are the ones to really worry about, as they indicate something is really amiss in the fundamental workings of the stock market. This recent correction, the market had in May 2012, definitely seems to fall to the uncertainty category in my opinion. The fact that enormous amount of buying has taken place in the US Treasuries in just 15 days, indicates that the liquidity is not in shortage.

Many investors are in agreement that when the need really emerges, the ECB will be there to backstop the eurozone crisis. So why the sell-off? In my opinion, it is basically a trading strategy used by some funds. When there is macroeconomic uncertainty funds sell stocks and buy Treasury Bonds. Why? Simply because that is what works.

That very fact, that funds only get moved around from the stocks to the bond market, indicates that there is no shortage of liquidity for funding the trades. At least so far. There is absolutely the possibility that Europeans might not be able the handle the developments still to occur in the summer of 2012. That could certainly change this to a real liquidity crisis that threatens the core of the markets. However, that has absolutely not been the case so far, as funds just gets moved around between stocks and US Treasuries.

My trading suggestion, to take advantage of this situation, is to short the 10-Year Treasury Bond IEF at the 1.70% level. For investors who are confident in a short-term sell-off in bonds more riskier positions can also be initiated with leverage or shorting the 20+ year bonds. The long bond trade has definitely been taken too far in just 15 days. There will most likely be profit taking from these levels.

Another factor to consider is Apple. The rise of Apple's stock was a big factor in the rise of the markets in early 2012. As the stock fell by almost 20% from the $630 level, it has definitely been one of the most important factors in the fall of the indexes and the damage to market sentiment. However, the Company is fundamentally cheap at the $530 level, as of this writing. At least in the short-term, there could be fundamental investors buying Apple stock. If that pushes Apple considerably higher that would increase the indexes, due to the heavy index weight of the company. Such an increase in the markets would then partially end the short stocks, buy bonds trade.

Disclosure: I am short IEF.

Author's Note: I have received some private messages in response to some of my trading suggestions asking for more specific advice. I am hesitant to do that because I am not an RIA in the U.S. However, investors who find my trading suggestions of good quality can use the "Follow" feature on SA. I post most of my trading suggestions in my articles anyway. So that is the more efficient way.