The watchword for today is "Oversold."
Bonds were oversold, and snapped back yesterday. The market got oversold and REALLY snapped back yesterday. Even the dollar, which has taken a 30% haircut over the past few years, is oversold and bouncing (more on the greenback later today).
The terms oversold and overbought get tossed about quite often. Unfortunately, many people (especially glib pundits and talking heads) use the phrase incorrectly.
What is Oversold? It starts when an asset class gets sold aggressively. Then it moves on to one (or more) of these three measures based on Valuation, Technicals, or Psychology. (The same holds true for "Overbought").
Following the selling, I define the phrase "Oversold" in any of these measures:
• Oversold on a Valuation basis is simply when an asset gets sold to the point below its intrinsic value. That can happen when downside momentum runs away.
• On a Technical basis, an asset is oversold when it hits the lower boundary of an oscillator. Think Bollinger Bands, or a Stochastics. Many technicians will consider an asset oversold when it is two standard deviations away from a recent price or moving average.
• The Psychology measure is trickiest, as it is the least quantitative. I think of an asset as oversold simply when too many people are on that side of a trade. Beyond consensus, a unanimity of view often leads to an asset being oversdold from a sentiment perspective.
Let’s look at the recent Bond selloff/yield rally as an example. Barron’s Randall Forsyth, in Bond Yields Were Too Low, obserrved that "Since May 8, when bonds started their trip south, the T-bond ETF has
lost a stunning 6.7% of its value. That would be equivalent to a
900-point drop in the Dow Industrials."
We clearly have the aggressive selling part covered. And the title implies there was a valuation issue prior to the selling. But what of the other measures? Consider the following:
"Only eight times since 1990 have bonds been this oversold, according to Birinyi Associates’ Jeffrey Rubin. Yet that doesn’t hold out much hope for a rebound, his data show.
During these episodes, Rubin found that T-bond futures prices were off an average of 1.72% a month after being this oversold. Three months later, they recovered but by a mere 0.15%. Nor did stocks stage much of a comeback in those instances: the S&P 500 was off an average of 0.16% a month later, and up just 0.14% after three months. Summer rally? Rubin’s numbers aren’t encouraging."
Eight instances over the course of 17 years satisfies the technical aspect of this — as of Tuesday, Bonds were more than two standard deviations off of their recent prices and longer term moving averages. And from a Psychological perspective, before yesterday, it was hard to find anyone suggesting that Bonds were a buy. That leaves only the valuation aspect in applicable as a measure of being oversold.
We will look at the Dollar later today to see if it is oversold and bouncing . . .
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Incidentally, the rest of the Barron’s article is well worth a read, as it goes into the details behind the bond selloff.
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Source:
It’s for Real: Bond Yields Were Too Low
Randall Forsyth
UP AND DOWN WALL STREET DAILY
Barron’s Wednesday, June 13, 2007
http://online.barrons.com/article/SB118168245007732937.html
Wow, this should be interesting when volatility increases and we get things very oversold –
S.E.C. Ends Decades-Old Price Limits on Short Selling
“The Securities and Exchange Commission voted yesterday to end price restrictions on short selling, meaning that investors seeking to sell a share that they do not own will no longer be barred from doing so because the price of the stock is falling.”
http://tinyurl.com/3bx5n8
Who needs regulations created way back in 1938, it’s different this time. Loot first, regulate later.
Good post Barry. At some point, housing will be oversold as well.
Greesnpend, that rule was obsoleted by technology. All you need is to send a buy 100 mkt to activated your sell short order.
There is one “new” variable associated to the status of oversold, which is the return of volatility.
No surprise as of April speculative funds were slowly reducing their net short position in volatility.
It seems applicable to all segments of the financial markets (interest rates,equities,foreign exchange)
According to Russ Winter, the FCBs were a no-show at this week’s 10-year auction. That could be an Uh-oh of epic preportions if the start of a trend. And the lack of FCB demand isn’t helping Bear Stearns and their CDO portfolio:
Quote: NEW YORK (Reuters) – A hedge fund managed by Bear Stearns Cos. Inc. is scrambling to sell large amounts of mortgage-backed bonds in a potentially troubling sign for the broader mortgage-backed bond market, The Wall Street Journal reported in its online edition.”
The underpinnings of the U.S. economy are financial – it is not based not on wealth creation but on wealth redistribution.
Regardless of indicators, PPI, CPI, or employment, it is credit tightening that can cause a collapse of Mr. Ponzi.
http://wallstreetexaminer.com/blogs/winter/?p=824
http://bigpicture.typepad.com/comments/2007/06/its_a_low_low_l.html#c72699852
OVERBOUGHT!longer term, bonds have barely begun to correct the massive “overbought” condition of the 22 year or so massive bond bull run which culminated in the price spike of june 2003.
Ferd,
Have you considered that the 22-year run in bonds you mention was just possibly a reversion to the mean?
How well do you know the history of bond yields in the U.S.?
“And from a Psychological perspective, before yesterday, it was hard to find anyone suggesting that Bonds were a buy.”
Tooting my tiny horn here – I did: Buying Into Bond Panic
amazing…the stock market opens and bond yields drop to the low of the day.
Another day of buy everything?
Today’s phrase should be: Printing Press.
Not even trying to hide it today…pretty obvious. two helicopter drops and we have’nt even been open for a half an hour.
Such utter rubbish….
Ciao
MS
I disagree Ferd Mertz. The bond momentum gauge that Hays uses went into deeply oversold territory last year around this time. It has had a PERFECT track record (so far) calling major buy points (when it hits below -100) in the bond market. It currently sits at 0. It does not get overbought until it hits 250.
Inflationary pressures are going to be good for gold.
Nice pump on low volume ….
The solace I take in watching this pump and dump on the SPY (and other stocks) is that it’s being brought to you by the very same people who brought you the Iraq War. And we all know how good a job they did with that…..
eventually cracks will appear…….they always do.
Ciao
MS
MS,
You seem to be on a personal crusade to shout down this market. We get it already… You’re a bear. We’ve heard you. The market is going to tank. Thanks for the info. Please start posting something new.
Thank you.
something new
Ciao
MS
Eddie,
And your position is?
It’s amazing how quite this blog becomes when good news hits the tape. Perhaps the CPI will give something to chat about.
You must mean the “good” underreported CPI numbers.
Or the rest of the news…..which is hardly “good”.
Ciao
MS
Looks like Stagflation for a few years coming to a theatre near you. Those rising prices lifting all boats feels pretty good right now, unfortunately future generations will have a real mess to clean up. How come the Fed stopped publishing M3?
i’m being somewhat sarcastic with the overbought commentary on bonds since 1) there never is inflation in the u.s.,2) foreign central banks love to buy low yielding u.s. debt in lieu of purchasing vital strategic resources or improving infrastructure for impoverished populations, 3)david walker’s scathing indictment of the u.s. fiscal situation using accrual accounting to adequately account for unfunded liabilities is irrelevant, since uncle sam has no intention of honoring future social security or medicare claims. yes, i’m aware of the history of interest rates in the u.s., as well as other places like argentina, indonesia, etc. reversion to the mean might imply a small real return on the ten year note and since inflation is probably running around 5% 10 year yields could easily be mean reverting at 7 or 8 %
Excellent rebuttal, Ferd. Your item 2 is especially insightful.
The mean reversion topic is a fair observation, but Barbarella:
http://en.wikipedia.org/wiki/Barbarella_%28film%29
…would’ve thought you too futuristic with the 7s and 8s.
Stocks are going to get crushed sometime in the next months.
There’s nothing “mean-reverting” in 100+ years of published American bond yields. Look at this picture: Corp Bonds 1830-2005 and tell me what the mean value is, how much did the yield spend at that “mean”, and how persistent that “mean” is through the full data. I’d say that every generation of investors gets its own “mean”, and there’s no telling in advance what it will be.
Small Investor Chronicles™
It clearly did spend the most time at or around “these yields”. Technology (read: productivity), and now globalization has taken inflation out of the picture, or a relative basis. Double digit yields are ancient history.
The conspiratorial theories are “humorous”. They make good blog copy though.
Fred, I’ll turn your paragraph around back to 1980:
“Abandoning gold standard (read: paper money printing), and now wage inflation has taken deflation out of the picture, on a relative basis. Single digit yields are ancient history.”
To wit: (1)inflation is a monetary phenomenon, has little to do with technology, etc.; (2) never say “never”.