There is nothing that I hate more than crowded trades. Too often positions that I thought offered the most promise end up being my worst performers. When I analyze where I went wrong – I inevitably come to the conclusion that although I thought it was a great idea – so did everyone else. I have learned the hard way that I should avoid trades where market participants are all leaning the same direction.
Therefore I read the following piece from the very thoughtful Jim Bianco with some alarm (quoted from ZeroHedge):
“Economists are unwavering in their assessment of where yields are headed in the next half year.
Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury yield to rise in the next six months.
The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.
Still, the fact that every single survey participant is bearish is striking. The last time the survey had that result was in May 2012, when benchmark yields were well below 2%.
“Literally there is maybe one economist in the United States straddling the bullish/bearish divide on interest rates. The rest are bearish,” Bianco writes.
He adds that a J.P. Morgan client survey shows that the percentage of money manager respondents who said they are underweight Treasurys is the second highest in seven years.
This is all the more surprising when we consider that investors went into 2014 thinking yields would rise significantly. Instead, the benchmark yield is lower than when the year started, as the market waded throw subpar economic data, geopolitical tensions, and uncertainty over the Federal Reserve. The 10-year note last traded at a yield of 2.72% on Tuesday, down from just over 3% on Dec. 31.
Then again, a separate poll of economists recently showed that exactly zero expect the economy to contract.
But when the entire market thinks one thing is about to happen, the opposite outcome is often in store, notes James Camp, managing director of fixed income at Eagle Asset Management. So don’t count out that result with Treasurys, he advises.
“It’s the most hated asset class,” says Camp, but Treasurys are some of the best performers year-to-date.”
This unanimous agreement that interest rates are headed higher is concerning. Economists’ ability to correctly forecast the economy has about the same success rate as Lindsay Lohan’s rehab attempts.
Lindsay’s mug shots over the years</a> </div>
I agree with Jim that when the economists all agree, the chances of them being right is very low.
The contrarian in me is attracted to the idea that maybe Treasuries are about to rally. After all, there is no one that is recommending an overweight or even standard weight in this asset class. Almost universally – advisors / portfolio managers / investors are avoiding the meagre interest rates offered by Treasuries and are instead venturing out the risk curve. A Treasury bond rally would certainly cause the most pain in the investing community.
In fact, even if the 10 year rate merely follows the implied forward rate, the economists are going to be spectacularly wrong. Have a look at the economists forecasts versus the implied forward yield:
Implied Forward Yield (yellow line) vs forecasts</a> </div></p>
There is a large amount of bearishness built into the economists’ forecasts. But what about actual positioning amongst market participants? Is this pessimism translating into short positions in the bond market?
Here is the CBOT 10 Year bond future net speculator positioning:
CBOT 10 Year net speculator positioning</a> </div></p>
Although they are leaning short, the overwhelming negativity towards the Treasury market is not translating into all time net short positions amongst the speculators. Speculators were more short in March of 2012 and also in April of 2010.
This lack of a large speculative short position corresponds to the apathy that I have noticed amongst the trader / hedge fund community in terms of opportunities on the short side of the treasury market. No one is bullish, but they are not falling all over themselves with bearishness either.
At the introduction of the first QE program many prominent hedge fund managers were predicting a dramatic increase in inflation and rates. In June of 2009, legendary hedge fund manager Julian Robertson was reportedly doing the following:
In layman’s terms, he is shorting long-term US Treasuries. Taken from eFinancialNews, “Steepeners are a type of interest rate swap, where one party agrees to pay the other a fixed rate in exchange for a floating rate, which is derived from the difference between long and short term rates. Many of these products also use high leverage, where the difference between the two rates is multiplied by up to 50 times to produce a higher return.”
Basically, Robertson has been buying puts on longer-term treasuries. He thinks rates could hit 7% easily and could go as high as 18%.
Robertson thought rates could easily go to 7% and maybe even as high as 18%?
And he wasn’t alone. Famed asshat Nassim Taleb said the following:
It’s “a no brainer” to sell short Treasuries, Taleb, a principal at Universa Investments LP in Santa Monica, California, said at a conference in Moscow today. “Every single human being should have that trade.”
The date for that trade that “every human being” should have on? February 4th, 2010.
US 10 Year Yield</a> </div>
It wasn’t only these two hedge fund managers that were bearish – it was a very popular trade. And I don’t mean to imply that I didn’t fall for the same “QE is inflationary” worry. I too was bearish on Treasuries at this point (although I would have never recommended that every human being should have the trade on… then again, I am not as smart as Nassim so I can’t make those sorts of recommendations.)
Obviously this trade went horribly awry for these speculators that thought rates were headed higher (luckily most of the human beings on the planet ignored Nassim’s advice). The inflationary QE proved to be anything but as the velocity of money plummeted. Those that were predicting higher rates spent the next 4 years getting thoroughly trounced.
Today all the economists are predicting higher rates but I am not sure that anyone is aggressively betting on that outcome.
Often for the crowd to be wrong, everyone needs to have already acted on that forecast. Although I accept that very few speculators are long Treasuries, I am not sure that there is a massive short position that needs to be bought back either.
If anything, I think that the move from 4% to 1.50% beat up so many bears that speculators are extremely reluctant to push the short side bets. They have all retreated to “easier” trades and have given up betting on higher rates.
I am not sure if I am talking my book, but I am inclined to dismiss Jim Bianco’s worry about the economists’ overwhelming bearishness towards Treasuries. I don’t think anyone is listening to them.
Maybe I am getting too cute, and maybe the Market Gods will punish me for even thinking this thought, but I do agree with Jim Bianco that since all the economists think one thing – something else is going to happen. What about the potential that they are all not nearly bearish enough? After all, when you step back and think about their 3.72% forecast for the end of 2015, and then compare it to the long term chart of 10 year rates…
US 10 Year Yield long term chart</a> </div>
Maybe the fact that we haven’t heard from our favourite asshat recommending the trade that “every human being should have on” anymore is the real contrarian signal.