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Mutual fund manager, CFA, registered investment advisor, macro
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"Go ahead, punk...make my day." - Dirty Harry

The S&P 500 (SPY) closed modestly higher on the week as yields (TLT) dropped marginally following new home sales data which badly missed expectations, a continued drop in mortgage applications, and lackluster job numbers. Homebuilder stocks (XHB), which tend to lead the market, have been getting hurt all year, and the yield spike is starting to negatively impact economic reports, with some construction stocks giving back all of the year's gains in a few short weeks. Followers of our analysis know that we have been warning of the dangers that a spike in yields can have on the economy and markets overall given historical evidence that shows what happens when the cost of money rises too quickly.

Nothing has changed on that front, though I continue to believe that the Fed will either hold off on tapering in September, or taper a very marginal amount given that the biggest source of reflation and economic recovery, housing, may be on the verge of weakening meaningfully if the behavior of housing stocks is correct. Credit market losses (LQD) in August have been large, making 2013 among the worst years on record for investment grade credit. I can not stress enough how much of an outlier environment this has become, since it is not normal at all for bonds to perform this poorly relative to the U.S. stock market which continues to hold up. The last time the spread of stocks to investment grade credit was this high was in 1999 - a rather ominous sign.

For us and our ATAC models used for managing our mutual fund and separate accounts, we remain defensively positioned on the shorter duration side of our opportunity sets. There remains a very distinct possibility that we rotate back into emerging markets next week. If the Fed ends up not tapering or tapering marginally, that will likely calm price action in emerging markets which have been correlated to longer-duration Treasuries as taper talk began. Furthermore, the fact that the central banks of India (INP) and Brazil (EWZ) are beginning to enact emergency action is a positive sign, as it forces action to counter Fed butterfly effects. That means both emerging market currencies (CEW) and stocks can rally meaningfully.

When we were in emerging markets (EEM) for two weeks this month, the trade worked very well, strongly outperforming the U.S. With numerous up days on down US market action. Many have been "hating" on emerging markets as of late, but since the June 24th low, broad emerging markets are up as much as the S&P 500. On a price ratio basis, the ratio never broke down and has instead been basing despite every single media story covering how awful those trade have been. For us, this is about momentum, but be aware that the biggest trades come when no one is positive on an investment.

One final note to stress here - for our quantitative models which we have dedicated our business to, it is historically unusual for us to stay in short duration bonds. Why? Because historically, when you want to express a "risk-off" deflation trade, you do so with longer duration bonds. The exception to this is if long duration bonds are actually the source of deflationary pressure. This is why the yield spike is so concerning, and why Fed action and central bank paranoia (the key difference between now and 1987) is so important. Our absolute return strategies are not designed to be correlated to the S&P 500 by maintaining constant equity risk. On the contrary - they are designed to run strongly when the right set up exists based on intermarket conditions.

It is so often forgotten in a world which believes in the illusion of consistency that patience pays.

Source: Ask Homebuilders About Taper

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.