"A mind all logic is like a knife all blade. It makes the hand bleed that uses it." - Rabindranath Tagore
Stocks ended the week higher after volatile movement to start the month of February. The week started off with a bang, as stocks fell the most since 1983, only to be followed Thursday and Friday with the best two day gain in several months. When all was said and done, the S&P 500 (SPY) closed up 0.84% while long duration Treasury bonds closed down a bit more than 1%. Many seem to be under the impression that the "correction" is over, but one of the characteristics of a correction is big downs followed by big ups. It remains to be seen if this is "over" but the combination of small-cap weakness, still resilient bonds, and continued emerging market volatility favors the Gray Haired Bears.
Regardless of fundamental, technical or economic analysis, logic must at some point come into the investing equation. Payroll data again missed expectations in January, with an insignificant upward revision to December's number. ISM manufacturing suffered a sizeable drop. The deflation pulse is being validated by data, and weather can only be an excuse for so long. Snow today has nothing to do with Treasuries maturing 30 years out. The Fed is tapering, and yields are either on balance falling, or stabilizing. At some point stocks need to pay attention to the reality on the ground. This iteration of QE has failed to juice inflation expectations, and economic activity. While QE1 and QE2 did cut off tail risk, QE3 may actually be causing it given lack of transmission into the economy.
Japan (NKY) is a good example of what can happen when QE is in place. The Nikkei year to date has had a big move down, despite stimulus which is higher than in the US. The illusion of stability which QE has brought in Japan has been faded as volatility picks up. Europe (VGK)? Deflationary pressures are significant. Whatever it takes is not enough to force reflation. Expectations are rising for the ECB to enact QE, but yields are already at historic lows in European economies. Why no one is getting nervous about all of this deflationary pressure in the face of trillions being pumped in to developed economies is beyond comprehension, but must be respected for buy and hold investors.
If economic data continues to disappoint, the market will have a hard time justifying last year's behavior. The rally on Friday was likely due to the belief that bad data means more stimulus. However, if that stimulus is not working to begin with, and the Fed is indeed "pushing on a string," then with hindsight it will be seen as an opportunity to sell. The only real counter to any of this would be a recovery in emerging market stocks (EEM) to keep bullish beta sentiment alive on equities overall. This is indeed a very real possibility in the face of emerging market debt which is laughing over terms like "crisis" and "fragile five."
For now, the two big trades continue to be long duration Treasuries on a resync to the reality of real deflationary pressure in the US, and emerging market stocks on a resync to the reality that there is no crisis. We remain optimistic that we can take advantage of them both when the time is right.
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.