"Surprises are foolish things. The pleasure is not enhanced, and the inconvenience is often considerable." - Jane Austen
The S&P 500 (SPY) rose last week following a very weak August as traders returned from the long weekend and re-adjusted probabilities of a Syria strike as President Obama decided to seek Congressional approval. The Fed's Beige Book emphasized moderate growth, auto sales came in better than expected, and ISM manufacturing was strong. None of this, however, translated into the Friday jobs report, which was highly disappointing. Not only did the August data miss expectations with whisper numbers considerably higher, but prior month revisions were lower. Some economists have argued the data was "just good enough" to keep the Fed on course for tapering, while others think tapering will be pushed out. Either way, the data seems to have complicated the Fed's expected timeline for pulling back on QE fully.
Emerging market stocks (EEM) staged a very powerful rally, strongly outperforming the US, but without their own credit spreads narrowing in a commensurate way. This makes the move last week a bit suspect, with persistent leadership important to keep an eye on. US bond yields rose aggressively Tuesday through Thursday as the 10 year (TENZ) yield briefly touched 3%, and then Friday resulted in a drop as jobs data was weak. US averages did well, but the move may have been more noise than signal given lower volume and historical higher volatility in September.
August was a solid month for us as our strategies outperformed both bonds and stocks as both fell through our rotation algorithms. Recently, our ATAC models used for managing our mutual fund and separate accounts rotated out of short duration bonds the week prior to longer duration exposure given confirmation in our signals. While the trade did not work last week, it is important to consider historical behavior. First, as I have been stressing in my writings, what is happening in the bond market is factually abnormal given the speed of the yield spike to begin with, and inflation expectations which are NOT trending in the right direction. The yield curve is abnormally steep in light of this and relative to its own history. This suggests a massive overreaction has taken place in bonds. Second, when long duration bonds outperform, they tend to do so in a major way. Since 2009, during periods where the S&P 500 corrects more than 5%, 20+ duration Treasuries outperform by an average of 16.7% (hat tip to Charlie Biello for this). With weakness in September historically coming AFTER the first week, such leadership in bonds can easily happen.
Make no mistake about it - 2013 has been an outlier year and one that investors should be careful of using as a way to judge a macro buy and rotate strategy. The iShares Moderate Allocation ETF (AOM) is up a mere 3.9% for the year. This has NOT been a raging bull market for anyone adhering to time tested and proven strategies of asset class diversification. I will end this writing by recommending everyone click this link which shows a chart that I have used in prior articles and media appearances. Be careful in thinking the bond market does not matter. This has never been about level of rates, but speed. What is happening now is reminiscent of historical crisis periods. For those unfamiliar with market history, I caution on looking at stock market gains month after month and assuming the past is representative of the future. Those who ignore context are likely to be as surprised about what markets do next as those investing in 1987 were in the moments leading up to the Crash.
Things will resync at some point, and we will simply keep rolling with the punches until they do. Be careful with small sample bias - its how nasty surprises happen.
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.