"Everything we hear is an opinion, not a fact. Everything we see is a perspective, not the truth." - Marcus Aurelius
The S&P 500 (SPY) in the U.S. rallied to new highs last week, undoing the taper scare as Bernanke reassured investors that low rates would remain in place for a prolonged period of time (hardly news), in what appears to have been a sharp about-face on monetary rhetoric. Specifically, the Fed Chairman brought up the very real deflationary pressures which have kept unemployment and growth depressed, arguing that in some ways "more accommodative" policy was needed.
This contrasts sharply with the various other mixed messages Fed officials have been publicly giving over an end to QE. The bond market did not fully believe the Fed, however, given that inflation expectations remain muted, and longer duration Treasuries did not perform as one might expect. Equity investors continue to believe in the reflation story which continues to be driven more by faith than reality.
Meanwhile, bearish sentiment has plummeted, and perspective on the "bull market" remains misguided. Many individual investors are looking only at the Dow and S&P 500, making the case that everything is great in the economy, the trend is higher, and money can be made. Unfortunately, the perspective on this assumes that one went "all-in" on U.S. markets. However, anyone that follows some form of asset allocation, something which time and time again has proven to be a very powerful way of generating longer-term returns, is by definition underperforming the U.S. Had Gold (GLD)? Bonds (TLT)? Silver (SLV)? Emerging Markets (EEM)? Europe (VGK)? Hedge funds? Then you are not "keeping up" with the "bull market" perspective which is driven by home bias.
I imagine much of the euphoria over equities in the U.S. is very similar to that which was felt during the first eight months of 1987 before the Crash. That is not to say that a massive decline is coming, but rather that you don't buy past performance. Any trade done today is buying the probability of future returns. The probabilities all year have been against the U.S. given the direction of inflation expectations. We have continued to hammer on this because we know the testing behind our strategies. Any environment that is an outlier and is characterized by continuous V-formations is nearly impossible to tactically rotate in as this one is with hindsight. However, environments change, and from that perspective we are excited for what the 2nd half brings.
Our ATAC models used for managing our mutual fund and separate accounts continue to favor bonds in the very short-term. The fat pitch remains Emerging Markets which can sharply outperform and begin a persistent period of outperformance in the very near future. The spread between the S&P 500 and the MSCI Emerging Markets Index is the largest it has been since 1998. You don't bet on mean reversion from the top, but rather from the bottom. Any closing of the spread between the two presents a meaningful opportunity for returns that could exceed that which has been experienced in U.S. averages.
And so we remain patient. When in periods of stock market euphoria, there is a temptation to throw all risk management out the window. We choose not to drive fast when conditions favor an accident, and given that the bulk of the year has been characterized by falling inflation expectations, we have no problem being cautious. Most realize that risk management actually matters only when its too late.
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.