"The next best thing to solving a problem is finding some humor in it." - Frank A. Clark
The S&P 500 (SPY) continued to power to new highs as commodities (DBC) faltered and the Dollar (UUP) rose last week. It is becoming increasingly more clear that we are in the midst of a outlier period for domestic stocks. The Dow Jones Industrial Average (DIA) this year has had its longest run without a three-day decline in over a century, while all economic signs continue to point to growth that is not accelerating. Housing starts missed expectations, industrial and manufacturing production data have come in worse than expected, and jobless claims increased notably. Of course, as I have been jokingly saying on Twitter, the "honey badger stock market don't care."
It is incredibly important to consider how unusual this year has become. Much of the advance had been led by low growth, high dividend sectors which outperformed for the bulk of the year until about two weeks ago. It is not opinion - quite factually when you have an environment which results in bond yields falling (TLT), inflation expectations dropping, and dividend sector leadership, markets tend to fall and become volatile. The bond trade worked, but did not work as well as stocks with the benefit of hindsight. It always seems easy to think that this was "bound to happen" - I see many people saying they "knew" markets would rally. I have my doubt that anyone could have predicted something that has not happened in over a century for the Dow.
The only way to have fully taken advantage of the move higher this year was to throw all risk management out the window, particularly during the deflation pulse that kept us largely in bonds for several months. One should judge the payout of a bet not on a single outcome, but rather multiple ones. To that end, we know our strategies and how markets historically behave, and indeed this is a period for the record books.
So the question now becomes what happens next. Our ATAC models used for managing our mutual fund and separate accounts favor stocks over bonds, with a rotation out of emerging markets and into domestic small-caps. Following news that the Fed has begun to discuss an end to Quantitative Easing, the Dollar surged, which is serving as a drag on emerging market ETFs (EEM) and their leadership/momentum. Being long emerging market ETFs is inherently also a short dollar position. The speed of the move due to the unexpected Fed tapering discussion has complicated the fat pitch trade in the here and now.
The Dollar's movement will be very important to pay attention to in the weeks ahead. I find it hard to believe that the Fed can pull back on QE when economic data across the board is still rather weak, and when there becomes the potential for an appreciating greenback to be deflationary for the economy. That means the recent dollar rise may not be justified and could reverse. This in turn, if it serves as a near-term trend in terms of a decline, would only further benefit emerging markets which are now underperforming the S&P 500 by over 1700 basis points. We maintain that a significant trade is coming in overseas equities. The Dollar's move has simply complicated the timing a bit.
For now, stocks still appear to be a better trade than bonds, given what appears to be yield curve steepening which may still be early. This means the anomaly bull run could continues to become more unprecedented. Things will eventually normalize. On our end, we will continue to do what we do by providing a true alternative to buy and hold investing, and one which we believe can provide better risk-adjusted returns through the fullness of time.
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.