The recent explosive rallies in the bond market have left investors in awe. Vanguard’s Extended Duration Treasury Index ETF (EDV) experienced a staggering surge of over 30% since the market lows in October. Naturally, this has led many to believe that the bear market for bonds, which plagued us from 2020 to 2023, is finally over.
However, it is crucial to exercise caution and not jump to conclusions based solely on these impressive gains. By observing the accompanying chart, we can identify similar-sized rallies that occurred on two other occasions during the bear market, which began in the summer of 2020. The first rally, spanning from March to December 2021, was followed by a sudden downturn as EDV plummeted by a daunting 50% over the next 10 months. The second rally, taking place from October to December 2022, similarly resulted in a 34% decline for the ETF over the subsequent 10 months.
These past experiences teach us an important lesson: not all significant rallies indicate the start of a new bull market. While there is no guarantee that the most recent rally will follow suit, we must remain cautious and not solely rely on its magnitude as an indicator of a bull market.
Edward McQuarrie, an emeritus professor at Santa Clara University in California, provides insight into this phenomenon. He remarks, “Horrible bear markets see ferocious bear market rallies… There’s every reason to expect that the bond bear-market, which began in 2020 and is considered one of the worst in U.S. history by several measures, will occasionally feature bear market rallies of equivalent force.”
In summary, while the recent bond market rally is undoubtedly remarkable, let’s not rush to proclaim the end of the bear market. History reminds us that caution is necessary, as true long-term shifts in market trends require more than just explosive rallies.
The Skepticism Surrounding the Recent Market Rally
The recent rally in the stock market has sparked debates about whether it signifies the beginning of a new bull market. However, skeptics argue that the future direction of the market is not solely determined by past performance, but rather by what happens next.
One key factor to consider is the outlook for interest rates in 2024. Currently, the futures market indicates that the fed funds rate will likely finish the year at around 3.75%, a decrease from its recent level of 5.33%. This expectation is already priced into today’s bond prices, which means that we should not expect a significant bond market rally from current levels if the fed funds rate simply ends the year at 3.75%.
A substantial bond market rally would only be expected if the fed funds rate declines considerably below 3.75%. Conversely, if the rate does not fall that far or, worse yet, rises from current levels, a bear market would likely resume.
The uncertainty surrounding whether we are experiencing the dawn of a bull market or simply a bear market rally is highlighted by McQuarrie, who suggests that there is no way to determine this in real time. If we were able to identify the true nature of the market, it would have already reacted accordingly.
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