"With confidence, you have won before you have started." - Marcus Garvey
The S&P 500 (SPY) hit 1700 for the first time ever as the US stock market on a nominal basis makes new highs, ignoring still lackluster GDP growth, jobs growth, and a continued major slowdown in mortgage applications. It is becoming extremely clear now that the Fed was wrong to think it could "taper" on QE, with several FOMC members now saying that an end to bond buying would make deflation potential even higher than it is now. We have maintained since the taper spasm began mid-May that the Fed would not end QE soon given the continued lack of demand pull and cost push inflation. Everyone looking at the Dow and S&P 500 are under the assumption that the economy is rip roaring. This assumes the Dow (DIA) and S&P 500 are correct.
The problem with this is that they could very well be wrong about the future as retail investors focus on the past as an indicator of the future. Stocks continuously go through periods of overreaction and underreaction. Studies show that the vast majority of individual investors fail to achieve anything close to buy and hold returns because by the time they identify a trend and put money into it, the trend is likely nearing its end as new ones form. It is also rather amazing how short people's memories are. From mid-May to the end of June, markets looked horrific. Long duration bonds (TLT) collapsed, emerging markets collapsed, and panic was setting in everywhere. Bernanke comes out, implying there would be no near term tapering, and suddenly a rip rally higher takes place. Hindsight is a convenient excuse to argue that one was wrong to be cautious on a momentous change in Federal Reserve tone, which sent markets tumbling, and in turn scaring the Fed to talk back tapering.
Forget all of that for a moment however and consider context before screaming about the bull market. Price behavior indicates this is a euphoria stage for U.S. averages, in a year where three major extremes have already taken place. First, the fact that stocks have rallied in the face of persistent falling inflation expectations is NOT normal, and not consistent with historical behavior. Second, bond yields have spiked relative to their moving averages in ways not seen over several decades despite continued Fed bond buying, and persistent deflationary pressures. Third, the gap between the U.S. and emerging markets has not been this wide on a year to date basis since 1998 despite no 1998-like event taking place.
For us and our ATAC models, half of our opportunity set of investments this year have experienced their own respective extreme moves. We did not create a strategy for outlier environments like this one, but around consistently observed variables and market behavior, which will re-assert itself at some point. This leads to the issue of market corrections. While most think about correcions in terms of falling prices, corrections can also be due to a re-sync of price to historical behavior. That means that emerging markets, which in the here and now we are currently positioned in, could close a significant portion of the gap relative to the S&P 500 and stage a major rally. That also means that bond yields can fall, and the U.S. stock market decline.
One final note - consistency is an illusion. As Nassim Taleb, author of the Black Swan, correctly says, markets do not crawl. They jump. The best and most legendary managers have track records which are lumpy in nature. It is rather stunning how so few realize that. Anecdotally, last week I received numerous emails from different people hurling personal insults at me and asking how we could be so foolish to be in emerging markets now. Somehow these people are forgetting that unlike others who do not have a process and invest based on a "gut feeling," we use a quantitative, unemotional backtested strategy to guide our portfolios. This is about relative momentum, plain and simple, and if that turns, we will rotate right out of emerging markets. We have every incentive in the world to perform strongly. We have staked our names, our reputations, and our resources as a boutique investment firm on this, and would not do so unless we had something powerful and unique to offer.
Such a burst of unsolicited emails have occurred on two separate occasions over the past two years. The first was in July 2011 when I consistently argued that intermarket analysis suggested a Summer Crash was to occur (it did). The second was June 4th last year when I argued a melt-up was about to occur (it did). Such emails have turned out to be perfect contrarian indicators in the past, and given how short-term everyone seems to be in wanting returns day to day, we think multiple corrections are about to take place in terms of the extremes mentioned
When others are sure you will be wrong about the future, you can be confident you likely won't be.
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.