Anatomy of a Bottom

The bond market did talk, and recently experienced a steep sell-off, one that had been forecast here by Macro Man, who charted the long bond quite frequently from late Summer onwards, and predicted some pain ahead for US fixed income investors.  Eventually this came to pass, although the trigger for the sell-off was an unexpected one to some.  Perhaps the removal of US election ambiguity was enough to persuade many to sell, or perhaps there were real macroeconomic arguments that will be proven sound in time.  What is clear, however, is that the selling seems to be over for the time being.  We say this despite the crescendo in the media (mainly from sell side analysts) that “interest rates are going higher”, and that there is a “great rotation” out of bonds and into equities. 

Why are we so confident that a bottom is in for US fixed income?  Price is News, my friends.  Let’s take a look at some charts, and we will review several different bottoms, for chart watchers who enjoy such things.  It is often easier to identify Bottoms than Tops, perhaps because of a variety of useful technical signals, such as RSI < 20, declining volume indicating seller exhaustion, and of course MACDs. 

After poring over many signals, we believe that the bottom is in for the following instruments: the closed end high yield muni fund IQI, for example, put in a low on the morning of November 14th, after two very high volume selling days (11/10 and 11/14).  We were buyers 11/14 and 11/18. 

Intrepid buyers on 11/14 have been rewarded with a 3% rally to go along with the 6% yield.  It is interesting that RSI never < 20, but this is the muni market, it’s mainly the province of professional fixed income investors and not manic-depressive (or 12 year-old) hedge fund traders.  Other ETFs that are more widely traded took longer to form convincing lows.  For example, the muni ETF MUB and the high grade corporate bond ETF LQD both made new lows in December, and this happened long after the RSI had reached its nadir <20.  The RSI made a double bottom in MUB, after which the ETF made a V-shaped bounce on high volume, a clear sign that the bottom is in:

LQD carved out a long double bottom formation after RSI dipped below 20 on 11/14; high volume down days in early December and mid-December specified a double bottom from which a recovery is now in progress:

We were buyers of LQD on high volume selling days, 11/18, 12/1 and 12/14. 

Finally, the Long Bond, a subject of speculative activity via the futures and options market, took the longest time to recover.  High volume selling days in mid November and early December eventually led to the formation of a long bathtub-shaped bottom in the second week of December.  We began buying TLT on 11/14, and continued on 11/23, 12/1 and 12/9. 

We note our buying dates to illustrate four things: 1) RSI <20 alone is not always a good guide in identifying a bottom, especially under extreme selling pressure, but it will usually be coming soon.  2) Beginning to buy and continuing to buy in tranches when RSI is <20 usually does work out OK a month or two later.  3) Waiting for RSI to reach 50 again will result in wasted opportunities.  4) Instruments that should “trade together” b/c “they are all bonds” in response to a stimulus such as “perception of rates going up” will not always do so in lock step, perhaps because the investor mix in IQI and MUB is different from that involved in LQD and TLT. 

So what happens next to Mr Bond?  The charts alone would seem to be telling us that a bottom is in and a slow recovery will occur.  Other factors in play in the short-term are pension fund flows (already trickling into the market and putting the charts into a much rosier light this week) and COT positioning (commercials are long the 10 year, while non-commercial speculators are massively short as Abee illustrated yesterday), which sets up the possibility of a powerful short squeeze in the next week or two. 

In support of the idea that bonds will continue to rally on mean reversion is the fact that long bond volatility of the magnitude seen during the recent panic was observed only in 2008 (GFC), 2009 (QE1), and 2015(taper tantrum), all very extreme events. 

The longer-term picture is more difficult to predict, and will be the topic of another post here in January.  Political factors and the Fed come into our thoughts when we look out into the future, so perhaps we will save the second post “Mr Bond Decides to Die Another Day” for the week of the Inauguration.  Nevertheless, as a teaser, take a look at the gaps in the chart for 10-year yield, around 2.20% and 1.90%.  Gaps get filled, my friends…

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comments

Great trades, LB!  I am looking for TLT reversal tomorrow or on Monday and a trip down to 115ish (selfish wish) where I would buy in size.  Weekly slow stoch is still embedded in sell mode, meaning that daily chart (with slow stoch in overbought territory now) was possibly a retracement within a longer term downtrend.  Not taking away from your great trades, just pointing out what I see.  I hope you are locking in at least some of those gains.  I think that we will see some prints north of 2.5% for a "got you" stop scoop before those 10-yr yield gaps you mentioned above get filled.  But what do I know...

I know that many people are out this week but quitle stunned by the lack of any volatility in equities given some of the fx action .  Vix looks like a very asymetric trade here to me and given the presumably illiquid state of equity indices is it not worth a nibble ? 

$AUD up 2.7% month to date looks like a nice vehicle fr those if a mean reversionary bent also, longer term techs are far from constructive and theres been a large bid fron the swaps market y-t-d .....alledgedly

did you see how the Bitcoin of Crime got demolished today?  a day after a piece by Vinny Lingham pitched it to late comers with target of $3000 max $4000 for the year

classic

the Erwartung of Trump inauguration is of the crumbling nature.  It's hard to imagine they could levitate in thin air for much longer so again great timing on VIX just don't get stuffed on the front month

I am along similar veins to IPA's thoughts.  I think you managed to pick the bottom of the bonds well so well done.  I mean the move down was very fast and ugly so does not surprise me we see a bit of consolidation especially given the relief that maybe USDCNY is not going to 10.00 anytime soon.  I personally do not think the move in USDASIA is over though and i am in the camp that market has yet to fully price any meaningful inflation / trump policy consequences.  If it is truly a structural shift (and i believe it is the start of one) then i think the moves / themes has a while to play out - although the ride might be volatile and choppy so buckle up! 

The bitcoin thing !!  amazing !!  all it seemed to take was the PBOC semi yanking the rug... so I guess we now know who the punters have been

Front month VIX expires 17th so yes I heed your warning but suspect we get a move prior to that if we are to get one at all. 

I'm continually amazed at how many otherwise intelligent people trade the ETN products, with such a steep curve, for the issuers it truly is the gift that just keeps on giving. 

I tried to not get back into work this year so early, but for whatever reason, my senses were a bit heightened by the almost eerie sense of complacency for what seems (to me at least) to be an extraordinarily high risk, low return environment. 

China seems to be lurching from one market stress to the next, yanking overnight depo on offshore to near 100%, banning the purchase of certain products with the 50k capital expatriation limit, adding liquidity via reverse repo at the same time, closing the bond market when they decide they don't like the price.  Surely it is a matter of time before the PBOC well and truly gets the shits and explicitly enforces capital controls ?  Maybe I am on my own on this one ....sure feels like it. 

All this in tandem with a US HF community limit long R2k at who knows what kind of valuation predicated on........Trump. 

I don't know, maybe I should take the rest of the year off , sell some vol at 13 and just chill the f___ out ! 

BTW, as a long time lurker and infrequent contibutor to this blog, I thouht I should at least make some effort to add to the discourse now that the status quo has changed.  Willing to take all the criticism that may come with that also

Yes, thanks LB, I'll go with the overpositioning and mean reversion argument on US bonds.  Having bailed last Summer I'm happy to trade this ,but not happy to reinstate an investment allocation which would have a different timeframe.  Let's see what a quarter or two yields for a long trade. 

Since everyone now is a bitcoin pro, remember its still up about 30% from where i was pounding on it about 6 weeks ago, just saying.  Price hit the previous high to almost the tick.  But as with most blow off tops, id be surprised if we dont gun for that level to break in the next coming days. 

Yes most of the bitcoin trading is from china, that is well known.  But there is also strong fundamental demand.  Look at number of bitcoin transaction or wallets. 

Also bitcoin has done this similar blow off the past 3 moves higher.  Each case was followed by new highs and relatively little shake if u got in early. 

Nico glad to see u back, thanks for that post.  Frankly recent comments have been some of the best ive seen in a while.  Thanks all.  And long time lurkers, common say something.  Like pol said many of you are rock stars.  Got me thinking of so many things.  Please consider posting officially as well. 

Since everyone now is a bitcoin pro, remember its still up about 30% from where i was pounding on it about 6 weeks ago, just saying.  Price hit the previous high to almost the tick.  But as with most blow off tops, id be surprised if we dont gun for that level to break in the next coming days. 

Yes most of the bitcoin trading is from china, that is well known.  But there is also strong fundamental demand.  Look at number of bitcoin transaction or wallets. 

Also bitcoin has done this similar blow off the past 3 moves higher.  Each case was followed by new highs and relatively little shake if u got in early. 

Nico glad to see u back, thanks for that post.  Frankly recent comments have been some of the best ive seen in a while.  Thanks all.  And long time lurkers, common say something.  Like pol said many of you are rock stars.  Got me thinking of so many things.  Please consider posting officially as well. 

The only reason that it garners any interest is that it is a price that moves, together with all the emotional response of missed opportunity or relief and schadenfreude. 

The only peopkle the price of Bitcoin has relevance to are those who own it.  Its price is completely and utterly irrelevant to every other function of life.  Unlike other currencies that affect costs of livings via trade and investment, or commodity prices of things society consumes or interest rates or anything else. 

Its fundamental value is that of the paper in a cheque book, or the plastic of a credit card.  No way would I want to hold a bitcoin longer than the nano second it takes to go from GBP or CNY to BTC to USD or whatever.  It is not a cash currency, failing the most important function of cash, that of stability and protector of value.  Bitcoin is complete and utter bollocks and even if its price goes to a trillion that doesn't prove me wrong. 

the most sensible e-currency would actually be pegged to a real currency. 

Have just updated my CV with "12yo HFM, as quoted in MacroMan" (see LB's excellent post above) and have decided it's about time I checked our fund's book.  Naturally, 2016 was defined as a FLOM year for us (f*ck load of money), due to being long equities in size, but I can't help feel even bigger opportunities lie ahead. 

As such I have started to investigate this bitchcoin that everyone is talking about, and we look forward to offering it as another 'safe haven investment' for our clients in the near future (watch this space). 

Faldo, welcome.  If you have a Bloomberg, CBT4NCN Index take the Net (Long - Short) of the Non Commercial players as a good proxy for sentiment/CTA positioning etc. ( Though commercial in Bond futures probably are a bit different from Commercials in Oil/Copper etc)

Nice post, LB.  JPM has some technical model using put/call open interest in treasury futures and COT.  It has a pretty good hit rate the last few years and is also bullish bonds here.  If bonds are going to rally, I'd expect this afternoon is a good time to buy using a tight stop. 

Most interesting article I've seen today is Marty Feldstein's piece on the border tax.  Surprising to see a free market economist like him supporting it.  Wonder what odds people put on border tax getting implemented.  GS has it at 30%.  Anyone have a view?  Using a 20% corporate tax rate, the border tax is potentially worth TWENTY-FIVE PERCENT in the dollar, so if people don't have a view on this, it's probably worth some thought. 

Anyone have an end of 2017 forecast for the US 2yr-10yr curve?  Currently at 120bps.  What are the odds we flatten out by year end?  I see the 2yr yield bewteen 1.5% and 2.0% and the 10yr between 2.0% and 2.5% by year end.  Anyone else think the curve could completely flatten this year? 

LB - have been looking forward to seeing your charting analysis for a while.  Great post. 

Curious about your IQI 11/14 entry.  What did you see different between 11/14 and 11/10 that made you enter on the former and not the latter?  Bottoms come after the fact and it's incredibly difficult avoiding the falling knife simply based on what I'm taking away from your analysis.  Great trades obviously, although I wonder if there's more to it. 

why would i fold when we finally get that bloody Dow 20k out of the way?  Considering time and price i'd double down now if i were not already all in.  Your 'haha' and 'lol' are painful to read the board appreciates adult wit, astute repartee

are you long spooz/Europe yourself?  at what level.  we can both follow each other's trade.  I'm 2228 on Spooz.  If you had paid attention estoxx was just an expiry (technical) trade close a long time ago the following Tuesday.  European banks can bounce all they want i ain't touching Europe. 

I have the feeling i'll stay solvent longer than you this long quarter, best of luck and good weekend everyone

PS: 2230 is the new pivot for March spooz.  I've sold tiny lots for friends and family accounts today and bidding 2232 for them.  This is a 99.99% probability trade that only comes up ONCE you're already on the market but i reckon the board would like to hear those simple swing trades

Nico, I concur on your spooz trade in terms of risk reward and likelihood of that circa 32 level getting tagged, although I do not have the trade on. 

Interestingly (or not) I see the Russell (cash) having topped on Dec 13th and now only a handful of points away from filling it's opening gap at the start of the year.  If we are to see some kind of risk off event with an accompanying liquidty drain then I like the idea that the illiquid stuff rolls first, rolls harder and takes longer to recover. 

The spec length in the future is quite unbelievable, if one was long it must be seriously butt clenching stuff.  So, happy to be short with a stop through the highs as I believe theres risk reward of 1:5 in that, at least. 

Not that I pay huge attention to it, though if anyone would like a good laugh, they could ring their friendly broker and ask them for their valuation model on R2k

I use a self derived technical system and prefer to sell something that is already going down.  I see a confirmed downtrend in the 4 hr time frame and an as yet unconfirmed sell signal in the daily time frame.  Longer term, obviously, it's all bullish, so it's a trade rather than a lifestyle for now ! 

Not to understate the importance of your 2232 SPX target (which is certainly doable), but I am looking for a complete undoing of Trump rally.  Yes, a shocking round trip all the way to Nov 8 close is what I am expecting, a piddly 6% pullback from here.  Your 2232 should be a brief stop on the way there.  The only way this happens is if the market finally decides that Trumpflation is not coming any time soon, if at all, which is not out of realm of possibilities.  I realize it's too early to proclaim any of this and I could be totally wrong, so please, no bashing of my opinion by perma longs here.  I know, "it's the hardest trade here, to stay long", at least that's what they'll tell you on the alphabet soup network.  C'mon, be a realist, the risk is hugely (pun) tilted toward a selloff due to so many headwinds just around the corner.  I say we start with a sour retail sales report and go on from there with so-so earnings.  Fedspeak will increasingly amplify the wage inflation message and crap will hit the fan so fast major longs will bail.  Really disappointed that Dow 20K hats were not worn today.  Let's get that out of the way early next week please! 

The only reason I am not short the S&P, despite sharing your fundamental view, is because I am generally loathe to short anything at an all time high and I am concerened that there may be a substantial short gamma position as we approach 2300 the figure.  If we see a subsequent spike and reversal through there I am tentatively willing to take the other side of that. 

I do not reside in the US, however, I am acutely aware of the fact that the S&P has become one of the only remaining liquid ways to hedge risk assets and as a result there are likely substantial option positions that I do not understand.  I also believe that the dumb money which arrives at the mature end of bull markets is often both retail and foreign and have witnessed that first hand in the last 6 - 9 months. 

If I am wrong on the US equity market and indeed the US economy, which I believe is weak, I have a reasonable long position in copper which should at least tread water, if not rally substantially in a DM or EM crack up boom. 

In January of 2011, Copper was trading around $4.60 / lb.  In December of 2015 It traded $1.95 / lb.  Personally, I am far more comfortable buying something that has declined c60%, is currently in a nascent uptrend and will in all likelihood be in deficit this year.  As an aside, I can say with reasonable authority that there is no new copper project anywhere in the world that is feasible at a price of less than $3 l/lb. 

In case anyone cares, I am far from a commodity bull, though when you see things like met coal and iron ore double and triple in a year, one has to take some notice no ? 

Copper... Inverted cup and handle with 25 penny distance.  I'll cover in thirds with 2.30 ultimate target.  Stop above 2.60 on two consecutive daily closes.  Don't want to get into a very long discussion on it again.  You could be right in a long run.  I am not looking for new lows, just a retracement back to the b/o @ 2.30

Not sure if you'll be interested but check out Ivanhoe mines in DRC.  It's a joint venture with the DRC and a company from China.  It's feasible with copper at less than $2/lb but even that has tripled since the December 2015 lows...

to clarify i am personally all in at 2228 average of course my personal target is below - moved up from 2050 to 2150 i.e. the undoing of Trump election rally.  i won't make money until 2228 but friends and family accounts (a mere 2% of size) who pick up the 'safe(r)' trades are the ones short from Friday who have a honest risk/reward ratio down to 2232. 

Mary Barra threw some no-nonsense water on the Trump fire this week end:

so far it's been all hope and imagination and anticipation on Trump promises from capital markets.  We are now entering a phase of pragmatism and increasing realisation that campaign promises may end up like mere wishes when they clash with reality.  Those clash might morph into long political battles with Washington spheres especially within GOP ranks

Great to see activity continuing on the blog. I am only an occasional (snarky) commenter, as I am down in Aus and apparently out of sync with the time zone of the majority; and more focused on the equity space than 'macro'. 

As there were a few commodity points raised, I think its worth pointing out the backlash in China around the smog in major cities.  Fridays IO, Coal weakness pinned on it (plus coming into China NY) and it is an increasing social issue there.  And I actually saw an article in the Guardian today saying London had already breached its legal NO2 pollution limit (related to Diesel fuel) this year and other Euro cities looking at restrictions on Diesel.  Interesting stuff.  Keep an eye on Solar, and conversely traditional energy as the cost per MW/h falls.  No positions to mention yet. 

Hope to see the discussion continue.  And more PM advice from 12yo.  Parody or not he is seeing it better than I!  haha.