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Mutual fund manager, CFA, registered investment advisor, macro
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Summary

  • Hawkish Yellen shocks short end of the yield curve.
  • Brazil and China show signs of life.
  • Alpha is beta rotation in disguise.

"Adversity causes some men to break; others to break records." - William Arthur Ward

A busy week on the global front coupled with monetary policy surprises on the domestic front sent the S&P 500 (NYSEARCA:SPY) in the US higher as emerging markets and bonds stayed resilient to bad news. Russia's "peaceful" annexation of Crimea seemed to be quickly forgotten by traders as attention turned to Janet Yellen's testimony for clues on the Federal Reserve's next steps. The Fed is clearly desperate in wanting out of the business of Quantitative Easing, continuing along the tapering course which comes as no surprise. However, a more "hawkish" tone by Janet Yellen seems to be what surprised market participants, as her comments caused investors in the shorter-end of the yield curve to worry about a sooner than anticipated rate hike to come in 2015. Long duration Treasuries (NYSEARCA:TENZ) held up well on the week, but it was really more the shorter-end (NYSEARCA:SHY) which acted in a more shocked way.

Yellen appears to want to set the record straight, removing the Fed's unemployment threshold target and putting the market on notice that rate rises are coming. This appears to be a calculated gamble given that she is well aware that inflationary pressures have yet to fully return to justify higher nominal rates. Perhaps by threatening rate hikes, urgency will be injected into the financial system to borrow money now at these rates before it's too late. The problem, however, is that Treasuries on the longer end may be calling her bluff. The fact that yields held strong despite tapering and the threat of rising rates suggests that market participants still believe things are no where near as well for the US economy as US equities believe.

The most interesting action, however, now appears to be happening in Brazil (NYSEARCA:EWZ) and China (NYSEARCA:FXI), both of which are likely crucial for emerging markets to finally lead the US on the upside. A strong basing pattern and potential breakout in the Bovespa seems to be underway on hopes for political change, while the Shanghai index had a huge move higher on Friday on stimulus bets. With what appears to be a crescendo in fund outflows from emerging markets (NYSEARCA:EEM) into PIIGS, a second quarter meltup scenario should not be ruled out.

With Yellen setting the record straight, I believe it's important we do the same as well. Our primary strategies are designed to be absolute return and uncorrelated to equities, serving as a complement to traditional stock and bond portfolios. For a year now, I have noted that massive macro disconnect between US equities and emerging economies. The reason for this relates primarily to the opportunity set of our alternative flavor of ATAC portfolio strategies. We rotate between US equities, emerging markets, and Treasuries. We have far outperformed emerging markets and bonds since inception, and 2011/2012 were strong years relative to US equities. However, the nature of an absolute return strategy is to rotate around risk and tactically position into disconnects on a resync to historical behavior.

The implication is that during corrections, our absolute return strategy has the potential to be in bonds, completely avoiding downside risk. In addition, whenever the period does come for emerging markets to rally, we have the ability to fully take advantage of that independent of US equity trend. This is precisely why our approach simply can not be compared to a constant buy and hold portfolio of US equities. It simply is the wrong benchmark. Over a full market cycle that includes periods of corrections, bear markets, and emerging market strength, it is conceivable that our absolute return strategy outperforms everything over time, all while being largely uncorrelated on average.

Having said that, do not mistake my focus on emerging markets as anything other than a disconnect which I believe we can uniquely take advantage of. Major announcements are coming in April which will not only surprise the investing and trading community from an academic/strategy standpoint, but also allow investors and traders the ability to position into a strategy that rotates into the right US sectors at the right time. Alpha is beta rotation in disguise, and for the first time ever we will be revealing a major component of our model's "risk trigger." Within the existing strategy, less risk is taken by rotating in bonds, making the strategy have the opportunity to go up when stocks are down due to the uncorrelated nature of Treasuries. Within a US sector rotation strategy, that very same trigger means maintaining constant equity exposure, but rotating into lower beta areas of the market to dampen downside volatility.

Such a beta rotation strategy would correctly use equities as the benchmark as that is a true relative return approach. Absolute return strategies such as the one used in our flagship approach can do very well during different phases of the cycle. This happened to have been a highly unusual one to be invested in for anything other than US equities. For those that are looking for a true equity rotation approach, I personally look forward to revealing what is our own gamble in the community - revealing a strategy which might just have the term "award winning" attached to it.

Source: Setting The Record Straight

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.