Explosive bond market rallies don’t automatically mean that bonds are now in a bull market. That’s important to keep in mind, given the undeniably impressive bond market rally since the October lows. (A proxy for the market, Vanguard’s Extended Duration Treasury Index ETF
EDV,
soared more than 30%.)
This rally has dramatically boosted investors’ mood, with many believing that the 2020-2023 bond bear-market is now over.
As you can see from the accompanying chart, similar-sized rallies have occurred at least two other times since the bond bear-market began in the summer of 2020. After the first such rally — from March through December of 2021 — the bear market resumed with a vengeance, with Vanguard’s Extended Duration Treasury Index ETF falling 50% over the subsequent 10 months. After the second such rally — from October through December 2022—the ETF slid 34% over the next 10 months.
Just because those two prior surges turned out to be bear-market rallies doesn’t mean the most recent rally will too, of course. But this history reminds us that you can’t conclude from the magnitude of the rally alone that a new bull market has begun.
According to Edward McQuarrie, an emeritus professor at California’s Santa Clara University: “Horrible bear markets see ferocious bear market rallies… There’s every reason to expect [the bond bear-market that began in 2020, which was the worst in U.S. history by several measures] will, from time to time, feature bear market rallies of equivalent force.”
There’s also a theoretical basis for skepticism that the recent rally automatically means a new bull market has started: The market’s future direction at any given time is not based on what came prior but on what happens subsequently. The bond market will go up in 2024 only if things turn out better than investors currently expect.
Consider current interest rate expectations for 2024. The futures market is betting that the fed funds rate will finish the year around 3.75%, according to the CME’s FedWatch tool, down from a recent 5.33%. Because today’s bond prices already reflect this expectation, you should not expect a huge bond market rally from current levels if the fed funds rate does nothing more than end the year at that 3.75% level.
You would expect such a rally only if the fed funds rate declines significantly further than to 3.75%, while a resumption of the bear market would be expected if the fed funds rate doesn’t fall that far or, even worse, rises from current levels.
This is why, according to McQuarrie, “there’s no way to tell in real time” whether we’re currently in the dawn of a bull market or a bear market rally. If we knew which it was, then the market would have already moved higher or lower to reflect that knowledge.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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