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Wall Street's Latest Lie: The 'Great Rotation'

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Ignoring the "Great Rotation" warning and buying bonds in February and March would have yielded 6% in less than a month.

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In February and March, when Wall Street was busy talking about the "Great Rotation" and telling investors to get out of bonds and into stocks, my firm was providing reasons to actually be bullish on bonds.

We outlined some reasons we were bullish that can be found in an article I wrote on February 21, Is the Great Rotation Theory a Myth?, as well as a follow-up published on March 13.

But how and why did we recognize the opportunity to go long bonds when the majority of Wall Street was clamoring to sell bonds? For starters, by checking the facts, ignoring Wall Street, and utilizing some common sense.

The Great Rotation Myth

News headlines frequently provide us with clues as to what Wall Street is trying to sell Main Street, which in and of itself can often be a reason to do the opposite. (We don't use headlines as an exclusive indicator, however.)

The latest example was the Great Rotation that dominated late January and early February's news headlines.

Once the money flow data was released for January showing decade high mutual fund (MUTF:VFINX) and ETF (NYSEARCA:VTI) inflows, Wall Street went crazy with reports that the "great rotation" was in full swing as it justified buying equities (NYSEARCA:VT) at the expense of selling bonds (NYSEARCA:BOND).

Remember these headlines?

"Have we entered the Great Rotation?" – Charles Schwab, February 6, 2013

"Are we watching a Great Rotation into Stocks?" – Time Magazine, January 28, 2013

"Trading the Market's 'Great Rotation" – MarketWatch, February 7, 2013

How about this for a headline: "They Were Wrong, as Usual" – ETFguide.com

There was indeed no great rotation occurring as we suggested in our article from February 21. We stated, "The facts simply don't support such a scenario of recent rotation".

In reality, the great rotation has been out of stocks (NYSEARCA:IVV) and into bonds (NYSEARCA:TIP) as bonds have outperformed stocks significantly since February 1.

Another Reason: The Technicals

On March 20, we published the following chart of the iShares 20+ year Bond Fund (NYSEARCA:TLT) which helped us get bullish on bonds in early March.

Source: ETFguide.com

Each time in recent history when bond prices made a new price high or price low accompanied by a volume spike, they typically reversed their trend (as identified at the bottom of the chart).

Combining this technical backdrop with the fundamental and sentiment analysis we outlined on February 15 helped us get comfortable picking a bottom on bonds as we suggested on March 10: "Given the positive divergence and volume spike low, aggressive traders can go long here with a tight stop below Friday's low of $114.62."

That stop was never in trouble as bonds immediately reversed their trend and rallied to $122.

Where Do Bonds Stand Now?

After rallying 6% since those long suggestions, iShares 20+ year Bond Fund was again accompanied by a large volume spike along with a few negative technical signals. We suggested for traders to take some profits on April 3 and longer term holders to also cash out on April 7, which accompanied the following chart showing another volume spike warning after a huge move up.

Source: ETFguide.com

We followed up our advice by writing: "Shorter term traders again may want to take some profits off the table with such an outlier of a move Friday. Now accompanying the rally is an overbought RSI as well as another volume spike (see chart) which may mark a short term top here."

After rallying 6% in under a month, it was a great trade and time to realize profits. Bonds have since given back some of their gains. Will the uptrend re-continue? What will be the next short term signal to go long?

Ignoring Wall Street's rhetoric and focusing on the facts that mattered most helped us identify a high probability trading opportunity as the Great Rotation out of bonds turned out to be the great fake rotation.

Editor's note: This story by Chad Karnes originally appeared on ETFguide.com.

To read more from ETFguide, see:

Direxion Adds Leveraged EM ETFs

PIMCO Total Return Fund Vs. BOND

Don't Get Hit By a Falling BRIC
No positions in stocks mentioned.
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