"The excessive increase of anything causes a reaction in the opposite direction." - Plato
Stocks in the S&P 500 (NYSEARCA:SPY) for the most part closed higher last week as investors continue to shrug off continued weak US economic data. Existing home sales and housing starts disappointed, and homebuilder confidence has not been encouraging. On the positive side, homebuilder stocks (NYSEARCA:XHB) haven't meaningfully broken down, but haven't really shown signs of contrarian strength either despite weaker data. Continued muddle through seems to still be the overarching theme in US equities. Meanwhile, although China HSBC PMI data came in weak, emerging equities continue to show signs of a potential reversal in the making.
It is becoming increasingly clear that demand pull inflation has been overhyped and is likely not going to cause reflation in the way the Fed originally hoped through the wealth effect channel. That leaves cost push inflationary pressure to do the heavy lifting. Commodities (NYSEARCA:DBC) have largely been on fire in February, in what may be a change in sentiment for global growth hope. While the "super cycle" in commodities may be over, regular cycles still do exist. Silver (NYSEARCA:SLV), Gold (NYSEARCA:GLD), Copper (NYSEARCA:JJC), and Oil (NYSEARCA:USO) are reversing disinflationary sentiment at the margin, which with a lag may finally help reverse emerging market outflows.
I have been on the emerging market theme for some time now. Our ATAC models used for managing our mutual fund and separate account took a few shots at the trade last year, only to be quickly out as momentum reversed and further losses took place in the BRICs. Positive signs are emerging as of late. The combination of strength in emerging market debt and commodities should, at least in theory, act with a lag on equities as investors notice the fictional aspect of the crisis negative narrative. China ETFs (NYSEARCA:FXI) have performed roughly in line with US averages since late January despite "surprisingly" weak economic data. Brazil (NYSEARCA:EWZ) in the last three trading days has had some interesting intraday price movement which appears to suggest some smart money may be returning to the trade. India (NYSEARCA:EPI) is far from falling apart given recent price action. Only Russia (NYSEARCA:RSX) is showing weakness, and this is largely due to protests in the Ukraine.
Meanwhile, fund flows out of emerging markets (NYSEARCA:GMM) continue unrelentingly. Almost a third of fund managers are underweight emerging economies, which is a "record level of pessimism" according to the Financial Times. A survey done by Bank of America Merrill Lynch cited "emerging markets… as the biggest risk for financial stability by almost 80% of [major fund managers]." No one seems to care about valuations or logic. According to Barclay's, the Price/Book ratio for emerging market stocks is below 1.5x, "levels seen during periods of crisis."
Remind me again - where is this "crisis?"
I have seen this movie before, and it ends up badly for those who leave the theater before the story is just about to get good. The Fall Melt-Up of 2011, and June 4, 2012 melt-up calls of mine for US stocks were all preceded by crisis pricing in the absence of an actual crisis. No one - and I mean this quite literally given my own personal exposure in the media - absolutely no one believes a melt-up in emerging markets may be about to occur. Ask yourself how exactly massive moves happen and how payouts take place. When everyone believes something, the payout is highest on believing the exact opposite, since you split the pot with fewer bettors. This is no longer a fat pitch that has taken far too long to materialize. This is about a melt-up in the making that will only be called that after a 20+% move has already occurred.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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.