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Anthony Crescenzi

Tony Crescenzi is Chief Bond Market Strategist at Miller Tabak + Co., LLC, an

institutional brokerage firm that deals with major institutional investors. His ability to dissect the markets and provide information in ways that people can understand has made him one of Wall Street’s most widely quoted analysts. He appears frequently on CNBC, CNNfn and Bloomberg-TV.

Books

The Strategic Bond Investor: Strategies and Tools to Unlock the Power of the Bond Market, McGraw-Hill Publishing Co, 2002

The bond market’s ‘crystal ball’

1. What are the top indicators to follow for a prelude to a bull market in stocks and a strong economy?

There’s a cavalcade of indicators that investors watch to try to gleam where the markets might be headed next. There are a few that I find invaluable. It is important, however, to look at them collectively, as there is no one indicator that is a crystal ball. You should follow: weekly mortgage applications, car sales, weekly chain store sales, the money supply, business inventories, the yield curve, and the spread between low-grade bonds and U.S. Treasuries or other high-grade securities.

2. What are the ten biggest factors that impact the shape of the yield curve?

There are a variety of forces that impact the shape of the yield curve. While the relative importance of each of these factors frequently changes, there are ten factors that have been and will likely continue to be the most influential for years to come:

 Monetary policy and market expectations on future Fed policy

 The level of economic growth

 Fiscal policy

 Inflation expectations

 The behavior of the U.S. dollar

 Flights to quality and the general level of investors’ risk aversion

 Perceptions about credit quality in the financial system

 Competition for capital between bonds and other asset classes

 Debt buy-backs by the U.S. Treasury department

 Portfolio shifts to reflect the markets’ level of bullishness/bearishness

3. What is the best way to gauge sentiment in the bond market?

There are several indicators that I use to gauge investor sentiment in the bond market. Over time, these indicators have reliably forecasted important turns in the bond market and hence, the stock market.

The call/put ratio on T-bond futures

The most reliable and widely tracked options to use in this regard are the bond options that trade at the CBOT. Although the supply of U.S. treasury bonds is shrinking, speculators still flock to T-bond futures to place their bets on the bond market. Using the 10-day average, a call/put ratio of over 1.4:1 has reliably signaled tops in the bond market and a call/put below 0.8:1 has reliably signaled bottoms.

Aggregate duration surveys

These surveys measure the extent to which bond portfolio managers are either long or short. Duration, a seemingly obtuse term, is simply a way to gauge risk. Portfolio managers generally maintain duration between 95% and 105% of their benchmark, usually the Lehman index. Aggregate duration at the extremes have reliably signaled turning points.

The 2-year T-note

Most don’t see the 2-year as a benchmark maturity but it is. The biggest signal that the 2-year T-note gives pertains to the bond market’s sentiment toward the Federal Reserve. Over time, the 2-year has been a reliable indicator mainly because of its stable relationship to the fed-funds rate, the rate controlled by the Fed. During periods when the 2-year has deviated from its historical relationship, this has pointed to the bond market’s true underlying feelings about the future direction of Fed policy.

4. How can I become a better Fed watcher?

Being a Fed watcher boils down to tracking the verbiage spewed by the FOMC - that cast of 13, including Greenspan, who vote on whether to raise or lower interest rates at FOMC meetings. One of the things that I tell people to do, and that many top investors already do, is read the text of the Fed’s speeches. Another is to look for key phrases that are repeated in lockstep by several Fed members. When I see a particular phrase used either verbatim or nearly so by a few members, I always sense that the phrase is a representation of current Fed policy. So, cracking this mystery is easy, since you know all of the key players and you know what they’re thinking.

5. Use of the yield curve to predict economic and financial events?

The closest thing that the bond market has to a crystal ball is the yield curve. For decades it has foreshadowed major events and turning points in both the financial markets and the economy. The yield curve is basically a chart that plots the yields on bonds carrying different maturities usually ranging from 3 months to 30 years. When bond investors analyze the yield curve to try to glean its meaning, they look at the difference between yields on short-term securities compared to that of long-term securities.

First, if it is ‘positively sloped’ this is usually an indication that the Federal Reserve’s monetary policy stance is and will likely continue to be friendly toward the markets. That is why the yield on short-term maturities is lower than on longer maturities (the Fed controls short-term interest rates). A friendly Fed is usually good news to stocks and to the economy. So a steepening yield curve generally forebodes good times for investors over a several quarter horizon.

On the other hand, a ‘negatively sloped’ yield curve usually indicates that Fed policy is unfriendly, with the Fed engaged in a strategy to slow the economy by raising short-term interest rates. This, of course, generally portends a gloomier set of conditions for the equity market as well as the economy. In fact, since 1970 every inverted yield curve has been followed by a period in which S&P 500 earnings growth was negative.

The yield curve is thought to be a better predictor of the economy than the stock market and can therefore give you an edge if you follow it.

6. Don’t be bullish just because you’re long!

Have you ever found yourself rooting for x and y to happen so that your investments might go your way? Does your portfolio rather than your investment criteria sometimes determine your next trade? In other words, do you find yourself bullish because you are long instead of long because you are bullish. If you answered yes to any of the above questions, you’re not alone.

Investors seem to have a knack for letting their portfolios affect their investment decisions and seem to forget who’s in charge. This was certainly the case for many dotcom investors in 2000, as there was no true basis for being bullish on these stocks. Next time you find yourself in a losing trade, ask yourself - truly ask yourself why you are long.

7. You can’t put being right in the bank!

It’s amazing how many people talk about how rich they could be “if only” they had acted when they didn’t or “if only” they had been more alert when trading opportunities were passing them by. These same people think it is just their bad luck that prevents them from those really great trades that always seem to be making somebody else rich. This performance disparity is often the result of excessive rational thinking. You know the feeling. You are contemplating an investment, and contemplating, and contemplating but then for a number of supposed prudent reasons, you rationalize yourself out of the trade. The end result is inaction and, perhaps, another missed opportunity. So the next time you find yourself saying, “if only”, remind yourself that you will be a successful trader “only if” you act on your ideas. Always remember: you can’t put being right in the bank!

8. Assess your physical condition when trading!

Most athletes approach their competitive challenges with some form of cognitive assessment of their physical ability to compete. After all, their ultimate success or failure depends upon it. In the same way, every trader should assess the impact that their physical well-being might have upon their mental abilities during a given trading day. A tired body could result in an impaired ability to trade with the mental reflexes necessary to react and respond correctly to news, information, and events. Thus, approach the trading day like an athlete would approach a competition and assess your readiness for the day. If for any reason you feel that you’re not at your level best, make adjustments.

9. Trade on your terms!

Would a driver who enjoys the challenge and thrill of negotiating a winding road at high speeds engage in such a challenge when driving conditions are poor, say, when roads are icy? In baseball, would a low-ball homerun hitter break from his upper-cutting swing to chop at high-ball pitches? Would a featherweight boxer arrange to fight a heavyweight and expect to win by KO in the first round? No chance on all counts! You should ask the very same questions when you are trading and investing.

You should pose questions such as: How do I normally fare in this type of investment? How have I fared in this type of trading environment? Should I exercise patience and wait for a better opportunity? Is the current level of market volatility a risk or a boon to my style of trading? Do I normally excel under these conditions? Or am I, perhaps, more apt to get chopped up?

You don’t have to trade, so don’t if you’re not comfortable. Why risk playing under conditions that don’t suit you? So don’t put your pedal to the floor when you are on an icy road. Be selective. Stay away from trades and investments that don’t work for you. You are in control of those black and red, buy and sell tickets. Trade on your terms!