- Too much focus on return, too little on risk.
- Oil could serve as catalyst for correction.
- Defensive areas remain stubbornly strong.
"Everyone has a plan until they get punched in the face." - Mike Tyson
The S&P 500 (NYSEARCA:SPY) rose to new highs last week as investors shrugged off rising oil prices, lowered growth forecasts by the World Bank, and disappointing retail sales. All news remains good news for large-cap stocks, with more focus on "how to beat the stock market" than how to manage risk. Small-cap equities appear to be trying to fight back from their correction, but a reversal could occur should defensive posturing re-assert itself soon. The combination of elevated oil prices and an already weakening consumer picture doesn't seem to be bothering anyone for now, as extreme bullish sentiment overwhelms prudence.
Oil is worth paying attention to independent of what is happening in the Middle East. It does seem reasonable to consider the possibility that money may begin to flow into crude given lack of any real trend for the past couple of years. If US stocks are right about the future state of the economy, oil prices likely must rise alongside as a signal of increased demand from accelerated economic activity. The problem with this of course is that rising oil could also put deeper downward pressure on the consumer, and also force the Fed to act faster if cost-push inflationary pressures build. The Energy sector relative to the S&P 500 appears poised to breakout in terms of overall leadership, which combined with Consumer Discretionary sector weakness may indicate the stock market is entering the late-stages of a bull cycle.
The two most stubbornly negative parts of the investable landscape remain of the opinion that things are fragile and that volatility could increase at a moment's notice. Utilities (NYSEARCA:XLU) relative to the S&P 500 appear to have broken their most recent relative downtrend, and Treasury (NYSEARCA:TLT) yields are still low in a way which indicates things are not that robust. Charlie Bilello and I discussed how Utilities and Treasuries both can be used to predict corrections and volatility in the CFA Institute webinar we presented last week which can be viewed by clicking here. As ingredients that go into the "secret sauce" of the ATAC models we use for managing our mutual funds and separate accounts, Utilities and Treasuries may push our strategies into defense mode relatively soon once again. Few realize this is the longest time period in history where the S&P 500 has been above its own 200 day moving average. Every day that goes by brings markets closer to a period when risk management matters once again.
The perception that money grows on QEs and that stocks can only go higher because "there is nowhere else to go" is the correction market participants need. Being prudent has penalized many for being defensive when conditions historically favor a higher probability of market stress. Since January of last year, traditional indicators which lead prior to market volatility have warned of fragile conditions as markets kept full speed ahead. A 10 to 20% correction is needed not to "flush out weak hands," but to remind investors and traders that risk matters, and that this has been an abnormal outlier period which one cannot rely upon as a way of generating security from securities.
If you're driving down a highway and you're about to enter a snowstorm, you don't want to believe a crash can happen or that the odds of a crash increase. You still need to slow down.
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.