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Mutual fund manager, CFA, registered investment advisor, macro
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"I find my life is a lot easier the lower I keep everyone's expectations." - Bill Watterson

Markets rose modestly in the second week of the year as traders and investors began shifting away from macro headlines to earnings season. There are some notable things happening within the stock market, as more conservative risk-taking behavior appears to be taking place. Emerging markets (EEM) hit up against a relative ratio resistance level and underperformed the U.S. after a strong period of leadership since September 2012. Our ATAC models used for managing our mutual fund and separate accounts got ahead of this the week before last, as money favored domestic companies which benefited from the Fiscal Cliff deal. On a country level, it appears that China (FXI) is still faring the best, but near-term, the U.S. appears to be in the midst of a catch-up trade.

Earnings will be important to watch, with what I suspect will be a large number of "beats" relative to analyst expectations. The level of conservatism was likely quite high during the tail end of last year given uncertainty over the elections, taxes, Europe, and the Fiscal Cliff. This means that analyst estimates were likely biased downward on fear that being too aggressive would result in career risk due to perceived headwinds and the negative narrative that was known all too well throughout the year. The question is never what earnings actually are, but rather, how the market responds to them. I suspect topline revenue growth will be the major focus, particularly in light of the ongoing belief that margins are near their peak.

Our inflation rotation strategies used in the management of our mutual fund and separate accounts remain fully exposed to equities, with no real signs of asset class deterioration just yet. We cannot rule out the possibility that we could rotate into bonds some time in February, however, this depends on whether earnings caused a shift in intermarket sentiment. The odds of a correction still appear to be low in the near-term, with the potential for a more meaningful drop in the second half of the year after the debt ceiling debate is done. Many seem to be under the impression that the debt debate will set markets up for another "Summer Crash of 2011"-like moment, but right now, that seems unlikely. The more realistic scenario still remains that stocks will continue to trend higher, eventually forcing Nouveaux Bulls in until some extreme in sentiment occurs coinciding with another deflation pulse.

With a bit more confirmation, the next rotation appears to be back into large-caps like the S&P 500 (SPY), which have lagged small-caps and are more sensitive to a pickup in overseas growth which China's markets seem to be anticipating. Given the weekly nature of our buy and rotate strategies, we may take advantage of the return of multinational strength by the end of the month at the current pace intermarket trends are moving now. Beyond that, my partner Ed Dempsey and I are actually quite excited for the next true risk-off period, given our ATAC models which are designed to rotate around bonds and stocks during changing inflation expectations.

As always, we remain ever-vigilant in our quest to beat the average by choosing the right average based on dynamic and ever-changing expectations and conditions. If Mr. Doodle...I mean Mr. Jack Lew and his squiggly signature were to cause a change in the behavior of stocks and bonds, we will simply listen to price for how best to accelerate time and capital for our clients. This continuous adjustment to price is something my father was a big believer in throughout his work, and in approximately three months time the re-release of his 1990 Intermarket Analysis book should help provide some additional background on the foundation from which our thinking was formed.

Disclaimer: This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Source: Earnings Expectations And The Next Rotation