"If something anticipated arrives too late it finds us numb, wrung out from waiting, and we feel - nothing at all. The best things arrive on time." - Dorothy Gilman
The S&P 500 (SPY) closed the week negative and bonds got a bid as investors digested news coming out of Europe with regards to Cyprus. The Federal Reserve reassured money that QE was still firmly in place helping to continue to support the housing and job markets which continue to show marginal improvement. Fedex (FDX) fell hard as the company lowered its 2013 earnings forecast, and Oracle (ORCL) took a hit on missed estimates. The reaction to these two companies might be indicative of what's to come if the market has indeed priced in overly optimistic fundamental scenarios in stocks against the backdrop of a muddle-through global economy.
Yes - this has been a good quarter for stocks in the U.S., while overseas equity returns have been considerably more muted, and emerging markets largely down on the year. On CNBC Friday, I called this the "honey badger stock market" which does not seemingly care about Europe (VGK), China (FXI), or anything that should give bulls pause. The outperformance in U.S. equity averages has made many bears capitulate, but deterioration still does exist beneath the market's surface. Whether any of this will matter is the $85 billion/month question in the U.S., while emerging economies have exhibited considerably weaker results. Since January 2nd, the MSCI Emerging Markets Index (EEM) is down over 7%. If markets are destined to continue to run higher, overseas equities are likely the fat pitch to play on the upside.
For the time being, however, we still remain cautious. Our ATAC models used for managing our mutual fund and separate accounts rotated out of stocks and back to bonds last week before the Cyprus news hit as a deflation pulse began to beat again. It appears that Europe's dysfunction is more bond bullish than stock bearish, causing us to largely outperform throughout last week's volatility. Not much has changed since then. Should a resolution to Cyprus be made, it is unclear how stocks will react. There is complacency in conviction happening now, with everyone under the belief that macro risks can be countered without issue. The stock market has not priced in a scenario where a deal would NOT get done, so it is unclear if one will matter for the bulls. The implication then is that the payout is higher that things actually deteriorate just as no one seems to think they will.
Cyprus in the grand scheme of economic activity is meaningless. What is more important is the precedent it sets for other Eurozone countries. It calls into the question Draghi's bluff to do "whatever it takes" to prevent a collapse in the common currency. Even if a bailout deal is agreed to, the cat is out of the bag. It will be hard to prevent a bank run, and at the margin banks in other countries could see money flee to safer banking institutions. From the standpoint of intermarket trends, next week will be important. The disconnect between internal weakness following Cyprus and absolute price levels must be resolved at some point. It is entirely possible we rotate back into equities by the end of the week, but much hinges on the behavior of markets in the days ahead.
Bottom line? Don't get lulled into complacency. Risks are building.
Additional disclosure: 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.