Utilities continues to predict coming volatility.
Emerging market strength competing with US weakness.
Defensiveness remains problematic.
"In skating over thin ice our safety is in our speed." - Ralph Waldo Emerson
This continues to be a tale of two markets for many investors and traders. While the S&P 500 (NYSEARCA:SPY) rose last week, certain industry groups and momentum names have gotten clobbered, most notable Biotech (NASDAQ:IBB) and Social Media (NASDAQ:SOCL). High momentum favorites have been sold relentlessly, reminding momentum chasers who bought in recently that when accelerated stocks turn, they tend to do so in a vicious way. Bonds remain well bid alongside defensive sectors, while at the same time there is clear movement occurring in emerging markets (NYSEARCA:EEM). There have been some meaningful inflows suddenly in popular emerging market exchange traded funds, and the trend of outperformance may just be getting started. Money has grown more comfortable with the reality that crisis pricing was never justified to begin with. Mean reversion is back, but may take a back seat to a possible corrective environment ahead.
We remain defensively positioned. From the standpoint of our main strategies, this means continued positioning in Treasuries which benefit from volatile equity periods. In a sector rotation strategy that focuses exclusively on equities, that means positioning into Utilities (NYSEARCA:XLU), Healthcare (NYSEARCA:XLV), and Consumer Staples (NYSEARCA:XLP). Our quantitative models have sensed a deflation pulse building beneath the surface, which equities on an absolute basis have not yet focused on. We should all be concerned with the fact that despite the Fed's clear intention to pull back on Quantitative Easing and bond buying, Treasuries remain strong. Furthermore, areas of the market which tend to be predictive of coming volatility are strongly outperforming. In the 2014 Dow Award winning paper "An Intermarket Approach to Beta Rotation," Charlie Bilello and I show that going back to 1926, the Utilities sector's outperformance tends to occur just as volatility is about to rise. I strongly recommend you download and read the paper, available on the Social Science Research Network.
Utilities have always been a component of our ATAC models, allowing us to avoid nearly every corrective period for stocks going back to 2010, while generating negative downside capture with participation on up moves. The behavior of small-caps and high beta names is concerning for the Nouveaux Bulls, but by the same token emerging market strength is concerning for the Gray Haired Bears. Friday may be a good example of what's to come, whereby US stocks close down hard at the same time emerging market equities end minimally in the red and Treasuries maintain the safety bid higher as low beta sectors hold up.
From our ATAC perspective, emerging markets remain a top pick once the current deflation pulse dissipates. While strength is real in emerging market equities, the risk is that bonds are signaling that all high beta areas of the market may underperform. Note that I am specifically referencing Treasury strength because of a second award winning white paper which will be released in the weeks ahead which touches on this subject in depth.
We will see how the coming week plays out, but for once it appears that investors are coming to their senses. Not only is the deflation pulse realization causing money to question why US stocks priced in so much optimism, but also the faux crisis realization is pushing money back into emerging markets. With job growth improving, but still missing expectations, and yields not exactly rising, it is worth considering how much longer US stocks can believe in the reflation case in the face of many other areas of the investable universe showing doubt.
To re-emphasize, I strongly encourage you download and carefully read "An Intermarket Approach to Beta Rotation." The paper will give strong insights into our alternative strategies and provide context on my own writings over the past three years. Charlie Bilello and I were honored for the paper Thursday in a video which is available on our YouTube channel. There will be two other major announcements coming in the weeks ahead, one of which we believe will be a major surprise for those looking for a strategy that recognizes that in an equity, long-only portfolio, alpha is beta rotation in disguise.
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.