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Paratrade Systems Weekly Research News

13 Jan

Our Current Bond Problem

Fear, as a factor in forecasting bond prices, is a weak factor. Institutional flows and responsiveness to fundamental factors like inflation and economic or stock market strength dominate. We can see points in time when fear hits an extreme and then we must ask: Does that mean we can expect a more extreme move? This is the market with a time series shown that measures bond fear:

Bond Fear

When bonds rally and fear is low, it is almost always because of corresponding stock market action. The rally of early ’16 occurred in spite of very low fear levels. Many bond investors and trend followers were able to make money in a crowded trade. In order to consider the significance of bond fear we need to take into account where stock market fear is at the same time.

Bond Fear 2

We are looking for periods of divergence. I have marked several and noted how the Post Trauma Window day count must also be considered. Vix can be a very fast mean-reverting series. Even after stock market fear has returned to lower levels after a spike the stock market may continue to rise, thereby hurting bonds.

A Test

  • Condition 1: Stock fear is low but above what we would consider to be bearish levels (>.4 and <1)
  • Condition 2: Bond Fear is low (<1)  and stock fear is low but above what we would consider to be bearish levels (>.4 and <1).

Bond Fear 3

In a sample period that is very bullish for bonds, (the last 10 years) the second case made no money while the neutral case (Condition1) earned 25 points. After accounting for the PTW we can trade these relationships.

Current Conditions

Bond Fear 4

Bond Fear has fallen to levels that are about as low as we can get. Any rally in stock fear (without an associated rise in bond fear) is very negative for future near-term bond returns. I am allowing for PTW since we are currently on day 48. I must also allow for severe moves in inflation. As of today, that factor is neutral.

Conclusion

Bonds may rally from here but they will need an unhealthy stock market to do so.

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