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

  • Bond market appears to be more right than stocks are about economy.
  • Parallels to 2007 and 2011.
  • Nearly all markets acting in line with each other.

"If you align expectations with reality, you will never be disappointed." - Terrell Owens

The S&P 500 made new highs last week while small-caps remain solidly below theirs as investors cheered first quarter GDP revisions which showed the economy contracted by -1%. Yes - that is actually a headline that for many seems to make sense. Why wouldn't equities rally when all news is good news independent of fundamentals and failed expectations? Pending home sales? Failed expectations. Personal spending? Failed expectations. Manufacturing? Failed expectations. Magically, large-cap stocks (NYSEARCA:DIA) simply don't seem to be bothered by weak data.

Meanwhile, Treasuries (NYSEARCA:TLT) are very clearly reacting to it. I wrote a piece for MarketWatch showing the remarkable parallels between the precursors to the Summer Crash of 2011 and today. Essentially, a massive distortion has now occurred. Defensive sectors have strongly outperformed the S&P 500, but Treasuries have largely been in line with the stock market since the second week of January. Nearly all outperformance in long duration Treasuries occurred in the first two weeks of the year, and everything since then has been simple compounding which has kept stocks and bonds neck and neck performance-wise. Charlie Bilello, our Director of Research, noted that from a cycle perspective there are many similarities to 2007.

I have long argued that it makes sense for large-cap stocks to outperform small-caps if emerging markets are about to lead because of the multinational growth factor that would then be in play by momentum traders. Friday a significant about-face took place in emerging market stocks, and yet large-caps levitated higher while small-caps again closed red. I don't know if people realize that the average stock is down this year, and that it has been abnormally difficult to "beat the S&P 500" given small-cap underperformance (NYSEARCA:IWM), Treasuries keeping in line, and emerging markets (NYSEARCA:EEM) still not as escape velocity. Yet, everyone's complacency appears to be justified, even though precursors to corrections and volatility are very much still around.

How much longer this rubber band will remain stretched is unclear, but bonds are screaming. Our ATAC models used for managing our mutual funds and separate accounts remain ready for a defensive rotation in our absolute return and equity sector strategies. Risk only matters for most after it's too late. In 2011, our models positioned us defensively the week before the August meltdown. In 2012, we had far stronger performance than the stock market by avoiding the May and October corrections. The tactical nature of our approach allows for aggressive rotations to occur. As is often the case when it comes to markets and life, extremes often define performance.

Will a Summer Crash happen in 2014? I have no idea. The clearest and most obvious difference between now and then is massive central bank intervention. With Draghi expected to announce new stimulus measures this week to counter Europe's deflationary tilt, for all I know stocks could continue to push higher because of more "money printing." However, if this money printing were expected to work, long duration Treasury yields would be rising. The fact that they are not is wildly underappreciated. This is not simply a supply and demand issue. This is a growth and reflation issue, and at some point stocks must come to terms with that.

Until then, badger on.

Source: Stocks Love Failed Expectations

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.