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

  • Inflation protection buyers step in.
  • Earnings will set tone.
  • Cost-push reflation hope is building.

"There are two ways of exerting one's strength: one is pushing down, the other is pulling up." - Booker T. Washington

The S&P 500 (NYSEARCA:SPY) rose strongly last week as positive seasonality pushed money into risk assets, reversing prior week losses. Oversold bounces in high momentum names caused some technical trading to kick in and push markets higher. Bonds (NYSEARCA:TENZ) sold off, but did not give back all the gain made in the prior week. While unclear if last week's market movement was more noise than signal, the most positive thing to happen was a sharp move higher in Treasury Inflation Protected Securities (NYSEARCA:TIP) relative to nominal Treasuries. Should inflation expectations finally be making a comeback, then conditions favor a continuation of the emerging market melt-up, rally in commodities, and floor under US markets.

What is causing reflation hope to kick back in again? The strength in emerging economies (NYSEARCA:EEM) seems to be one factor. As money gets more comfortable in investing overseas, there becomes a natural feeling that infrastructure building in these countries will pick up. This appears to be most evident in Copper which has abated its breakdown from early March at the same time energy prices have been rising. Demand for inflation protection in the TIPS market may be on anticipation that CPI data is set to surprise on the upside. Whether this is true in actuality or not is meaningless - perception sets price. Looking at the Energy sector (NYSEARCA:XLE) relative to the S&P 500, a sharp period of leadership kicked in just over the past few weeks. A revaluation is occurring, and may just be getting started.

For our ATAC models used in managing our mutual funds and separate accounts, we remain defensive entering into next week. While some improvement did occur, intermarket movement was not enough to push us out of our current positioning. With earnings season kicking into high gear, the tone should be set for what happens next. From an absolute return standpoint, the next rotation likely is out of Treasuries and into emerging markets which appear ready to be the next cycle leader given clear divergence in the last month. From a sector standpoint, Materials (NYSEARCA:XLB) in particular look interesting, and movement out of defensive areas like Utilities (NYSEARCA:IDU), Healthcare (NYSEARCA:IYH), and Staples would then be justified.

It is worth noting that 2014 is clearly not like 2013. Stocks have largely gone nowhere in what is otherwise a favorable period for risk assets from a historical perspective. There is no question in our opinion that historical relationships are returning, and that cause and effect are reasserting themselves. Our weekly buy and rotate alternative strategies, in both absolute form and equity sector rotation form, stand ready to position where historical odds most favor leadership. As our 2014 Dow Award winning paper "An Intermarket Approach to Beta Rotation" shows, better performance and volatility management are absolutely possible, but require consistency of action and time.

In the next two weeks, we will be releasing our second award winning paper. The analysis will provide an additional layer of understanding for those interested in a true buy and rotate approach. Traditional portfolio theory argues that it's important to have non-correlated strategies as part of an asset allocation approach. Most hedge funds do not have correlations which fit the bill. It's important to consider those that have true zero relationships over time to enhance upside and reduce downside moves. Everyone wanted non-correlated strategies in March 2009. No one wanted non-correlated strategies in July 2007.

Ask yourself - when is the best time to position into something different: before the move happens, or after?

Source: Cost-Push Reflation?

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.