"Change, when it comes, cracks everything open." - Dorothy Allison
The S&P 500 (NYSEARCA:SPY) for the most part closed flat last week following a strong October in what continues to be a "resilient" environment for bulls. US markets in 2013 have had a sizeable move as QE-euphoria increases not the velocity of money in the economy, but rather velocity of trading in developed equities. Risk management continues to be a thing of the past as everyone automatically assumes that November and December will be strong months. Indeed the bears have been right in their thesis about the economy. Data has been mixed (solid manufacturing coupled with poor jobs growth), and there has not been any acceleration in overall activity which earlier in the year was the bull argument.
Bubble talk is growing in the community not in terms of where we are now, but rather where we could be if the Fed does not begin to taper enthusiasm. Quantitative easing has not increased inflation expectations, nor increased hiring in any real meaningful way. The wealth effect is not affecting the economy, but rather it is simply affecting the wealthy. The Fed needs more time for its policies to filter to the real world, but at the rate the stock market is going, they won't have the chance. The way to buy time is to talk down stocks to cool the pace of acceleration before a 1999-style scenario repeats.
Beneath the surface, risk-off behavior continues to take place as defensive sectors get more of a bid, at the same time speculative high momentum trades crack. Social media stocks have started to meaningfully break down relative to the broader S&P 500, and high beta small-cap names are weakening in an accelerated way. Could this be a warning of a deterioration in the market's overall trend? Our ATAC models used for managing our mutual fund and separate accounts still favor long duration bonds relative to stocks in the near-term. While there appears to be a feeling of invincibility in equity markets, hubris has a funny way of reversing months worth of gains in a period of weeks.
With hindsight, it is clear that 2013 was the year of buy and hold for US stocks despite several metrics that suggested otherwise, most notable inflation expectations. Anomalies happen, and one can not create a strategy around outliers but rather observed correlations and causation. It is extremely unlikely that stocks continue performing as well as they have this year during the next 12 months, unless we are 1) in a true bubble, or 2) re-entering the 1990s all over again. The implication of this is that it is worth considering how to best accelerate time and capital based on future probabilities, rather than past gains.
Within the equity space, emerging markets (NYSEARCA:EEM) continue to look very attractive as a mean reversion trade relative to developed economies. Indeed the fat pitch has taken longer than we thought it would to materialize despite a strong September and October. We have been able to take advantage of powerful relative momentum as it occurred, but persistence has been relatively fleeting. The thesis remains the same as to the spread differential between the US and the BRICs, which is why we do believe a big trade that will last several months will come. As to the bond market, it is increasingly clear that the yield spike was unwarranted earlier in the year, and that inflation expectations have been right to not increase on anticipation of economic acceleration.
Remember - gains need to be permanent in order for portfolio values now to be anything other than a snapshot of wealth. It remains to be seen if US stocks in the future can continue to be divorced from reflation, realty, and growth. The Fed may soon realize that, and taper equities
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.