wmeubank@ocp.kcmo.com
FISHBACK MANAGEMENT & RESEARCH
P.O. Box 23798, Lexington, Kentucky
(March 26, 1997)
JUNE BOND FUTURES:
It doesn't happen often, but our trading model is telling us to stay on the sidelines with respect to new positions. Our bond market remains bullish, but only by the narrowest of margins. Meanwhile, volatility has dropped to an unsustainably low level.
As far as our market indicators are concerned, the yield curve is positive,
even after the Fed's latest action. The 3-month T-bill is priced at 5.21%,
while the 6-month bill is priced at 5.36%. That's a positive spread of
15 basis points and is bullish. At the same time, the trend in bond prices
is bearish. The only positive factor in the price action of bonds is that
they are finding support when the cash bond yield hits 7.00%. Significant
penetration of that level would be devastating for bonds, and probably
for stocks, too. Speaking of stocks, the trend in interest-sensitive stocks
is on the verge of turning neutral, as there has been a rather pronounced
sell-off in both utilities and in financial stocks. One potentially bullish
factor is that sentiment in the fixed income arena is extremely bearish.
From a contrary opinion point of view, that is positive. This indicator
category is on bull alert and will move to bullish if and when sentiment
actually begins to improve. The key to staying on the sidelines, however,
has nothing to do with our directional indicators but with our volatility
indicators. Implied volatility, a measure of an option's price, is extremely
low. In other words, bond options are cheap. As with any asset, you buy
low and sell high, not the other way around. Since high probability credit
spreads are primarily an option selling strategy, if we did anything now,
we would be selling low, which is the opposite of what we want to do. Moreover,
historical volatility is extremely low. That means, as hard as it may be
to imagine, the market has been too quiet! That typically means that a
big move in bonds is likely, which could be detrimental to our strategy.
Therefore, we want to stay on the sidelines as far as new positions are
concerned, and simply hold our open positions.
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