"There's a moment in every book when the book turns and it surprises me." - Chuck Palahniuk
Markets started the second quarter with a whimper, rather than a bang, ending lower with global weakness in the cyclical trade getting more and more pronounced. The chatter after the end of the first quarter was focused on the idea that money would rush into stocks as headlines emphasized equities in the U.S. closing at new all-time highs. The rotation out of bonds (TENZ) and into stocks, the narrative went, would begin in earnest. The problem, however, is that intermarket deterioration had only gotten worse. Ed Dempsey and I have been continuously writing and talking about internal dynamics which are completely inconsistent with U.S. stock market euphoria. As I said on CNBC Wednesday, with where the stock market thinks we are in the economic cycle, bond yields should not be falling.
The price action was fascinating to watch. Our ATAC models used for managing our mutual fund and separate accounts maintained their defensive stance through being in bonds despite hype over a continuation in equity price strength. While the Dow (DIA) and S&P 500 (SPY) began to wobble, there was significant weakness occurring starting Monday in U.S. small-cap stocks (IWM). I specifically wrote that the substantial underperformance in the Russell 2000 which seemingly came out of nowhere might be the correction tell. Given that small-cap stocks are more sensitive to domestic growth expectations than large-caps are due to their more global operations, the breakdown seems to have taken many by surprise. After all, the thinking all along has been that the U.S. would to continue to diverge from other economies because of a pickup in our own growth.
Meanwhile, throughout the week bonds kept on performing well. On Twitter, I said numerous times that the bond market was screaming that the deflation pulse, which we have alluded to throughout the last several weeks, is beating faster. It was unclear why, up until Friday. I highly recommend you visit thestreet.com and search for the video "March Jobs Report a Big Miss." I did a live interview as the jobs data was released, specifically saying that the bond market seemed to think it would come out poor. The actual number came in considerably less than most estimates, and bonds surged in one of the best weeks since August 2012 for Treasuries. Small-cap stocks closed down almost 3%, cyclical emerging markets fell hard, and fragility remains very much intact.
The disconnects within the market need to be resolved. U.S. averages have not yet corrected, but all things which lead during corrections are indeed doing so, and the "risk-off" trade has been working. The fear being expressed in the bond market with the collapse in yields last week must be respected. It is entirely possible that stocks refuse to fall, but Ed Dempsey and I do believe that a Spring Sync will occur such that absolute price movement converges to intermarket trend movement and deterioration. Earnings will be the ultimate catalyst, given that it many ways U.S. stocks are pricing in a considerably more optimistic scenario than the bond market.
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.