- Everyone worried about correction, no one doing anything about it.
- Reach for yield not just a talking point.
- Selective correction either start of something bigger, or end of decline.
"Inaction breeds doubt and fear. Action breeds confidence and courage. If you want to conquer fear, do not sit home and think about it. Go out and get busy." - Dale Carnegie
Last week was a particularly busy one for Director of Research Charlie Bilello and I, which explains the lack of article writing on various sites I contribute to. I attended the Uncommon Knowledge conference, sponsored by the National Association of Active Investment Managers (NAAIM) down in Florida. Part of the reason for attending was to show support, as well as to accept the 3rd Place honor for the Wagner Award white paper titled "An Intermarket Approach to Tactical Risk Rotation." On Tuesday, I presented to around one hundred active managers the topic of that paper as well as the Dow Award winner discussing the predictive power of Utilities in what could otherwise be considered an hour-long education on intermarket analysis. The time spent was great, and I received wonderful feedback from the audience who was kind enough to listen to the research we conducted.
In addition to the time spent at the conference, however, Charlie and I went around to surrounding offices of major brokerage houses in order to present our ATAC strategies, essentially doing walk-throughs one by one to each advisor. Several themes were universal in every single independent conversation we had. The first was the desire for yield. One thing is to hear about how pervasive the need is for income in the media, but the kinds of things advisors would tell us was remarkable. Anything with yield? Clients love it. Doesn't matter what principal risks are taken. So long as that monthly check was coming, nothing else matters.
The other major theme? A correction is coming, and we're nervous, but remain fully invested to the hilt due to client pressure for more equities. Now keep in mind these advisors are highly sophisticated and understand market dynamics. There was undeniably a bearish tone across the board, but no one was seemingly doing anything about it. There was a lot of interest in our alternative, non-correlated inflation rotation strategies precisely because of concerns over yield chasing and stock overweighting, but broadly speaking it seemed no one was worried to the point of actually taking pre-emptive action. This struck us quite a bit. No one wants to fix the roof until after it's rained, and the idea of risk management before the risk manifests seems too ideal for most.
Yet, the signs are around us that there is fragility. Clearly a selective correction has been underway. The Russell 2000 small-cap index (NYSEARCA:IWM) did close below its 200 day moving average last week, and high beta momentum names deemed as "safe" have gotten wrecked. Large-cap indices have held and masked tremendous rotational weakness. Charlie Bilello noted recently the last two months saw the S&P 500 up with the Russell 2000 down at the same time - something which has never occurred in history. Few seem to be appreciating just how unprecedented market action has been so far in 2014, with yields dropping, defensive sectors outperforming, and large-caps so desynced from small-caps.
It appears everyone is now hiding out in broad large-cap averages, as momentum remains hard to turn negative just yet. To some extent, the bulls have a very legitimate argument here. There has been a correction, and we are long in the tooth in terms of intermarket behavior warning of a period of broad market weakness (which has occurred in small-caps but not large-caps). In other words, the moment has passed. The bears, however, will argue that all of this is equivalent to the "whites of the eyes" of a nasty period of volatility ahead. Both are logical arguments, but only one will be right.
Right now, our weekly-run ATAC models used for managing our absolute return and equity sector rotation mutual funds and separate accounts remain in "risk-on"/expansionary mode, but not in a way suggestive that things can't quickly turn around. The rotation out of defensive sectors and long duration Treasuries helped last week, but coming days could alter dynamics. The sentiment out there is extreme in terms of not just chasing yield, but also in talking about a correction with no preparation for it from an asset allocation perspective.
For us, that's the kind of environment we like. Everyone thinks they can slow down their car in a rainstorm just in time to avoid an accident. Too bad evidence shows that accidents can happen in the blink of an eye, and that it's crucial to pay attention to the red lights at the very edge of the horizon.
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.