The Spring Switch Of 2012, Or The Great Reallocation

| About: iShares 20+ (TLT)

"All truth passes through three stages. First it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident." - Arthur Schopenhauer

Once again it's time to address the next major "call" as spring begins. As followers of my intermarket analysis and approach to investing are aware, I deeply believe that conditions matter more than predictions, and that the primary conditions that matter for markets being risk-on/off are rising/falling inflation expectations. I do my best to interpret the message price sends. It was by listening to the market that led me to call for the "Summer Crash of 2011, or the Great Re-Adjustment" call back on June 8th, before the August/September declines and historic volatility that followed (here). The Great Re-Adjustment was the swift move back into bonds and out of stocks through a sharp break in risk asset prices.

Toward the end of September, I began noticing some dramatic disconnects that actually signaled bullish conditions were returning in the midst of the eurozone crisis and scare. Despite massive bearishness still expressed by analysts and strategists, listening to the market suggested a very different set of conditions were expressing themselves. I began writing about the "Fall Melt-Up of 2011, or the Great Surprise" on September 29th, right before the October 3rd low and historic move up in that month (here). I specifically stated in that article that "I believe there is a growing possibility that the mother of all counter-rallies is coming very shortly."

Admittedly, I got whipsawed in early November as Italy's bond yields shot up overnight to over 7%. The inflation/deflation question and answer switched back and forth, and it looked like the move up would likely end until SuperBen and the League of Extraordinary Bankers stepped in at the end of November by lowering dollar swap rates. Markets ended 2011 on a deflationary note, and I became more negative as market internals continued to suggest weakness was likely. However, despite this my next major call was the "Winter Resolution of 2012, Or the Great Relief" which I first wrote about on December 22 (here). I argued that "the state of uncertainty internally within the market likely will not persist for much longer...(and that) the Great Relief is that the likelihood of this period (of high volatility and high correlations) ending is probably very high."

Following the first week of January, I noted in my company's free weekly e-newsletter that market internals dramatically altered at the start of trading for 2012. On January 5th, in an article titled "Financials, Bullish Sentiment, and the 2012 Winter Resolution" I noted that "market internals seem to be suddenly betting on rising inflation expectations, and should this continue, I think it's game on for the bulls" (here). I have remained bullish ever since, and made several arguments that 2012 could be a year of reflation similar to 2003 and 2009 for risk assets, with the possibility of significant gains to come for stocks, even appearing on CNBC alongside Amanda Drury making the case on-air (here).

I believe we are now headed for the "Spring Switch," which is the idea that money will likely switch out of bonds in earnest and into risk assets in an accelerated way. This "Great Re-Allocation" appears likely now that bond yields are finally rising in a meaningful way (due largely in part to the bank stress test results of last week), and because it's hard to be so negative on the near-term given that despite Greece defaulting and everyone's belief that the end of Europe was here, the Dow (NYSEARCA:DIA) is above 13,000, S&P 500 (NYSEARCA:SPY) is above 1,400, Nasdaq (NASDAQ:QQQ) is above 3,000, Nikkei (NYSEARCA:NKY) is above 10,000, etc. It turns out the stock market may have been right after all about the future.

Take a look below at the bond/stock ratio of the iShares Treasury 20+ Year Bond ETF (NYSEARCA:TLT) relative to the Dow Jones Industrial Average . As a reminder, a rising price ratio means the numerator/TLT is outperforming (up more/down less) the denominator/DIA.

Click to enlarge

I've annotated the chart to show relevant periods of how the ratio behaved during key junctures for markets. Notice the far right of the chart. While stocks on an absolute basis are largely back above the pre-Summer Crash levels of last year, the TLT/DIA ratio has not returned back to prior lows. This suggests that a lot more room for further weakness in bonds relative to stocks is likely, and that money can continue to come out of safety plays and into risk. Operation Twist cannot fully explain this disconnect, considering that bond prices rallied in the absence of Fed intervention (following end of QE2 in June and start of Operation Twist in late September which coincided with the peak in the ratio). Prior history of Fed intervention also resulted in rising yields despite their desire to keep rates low.

And so we enter the Spring Switch - the switch out of bonds and into stocks and the switch into the mentality that once thought things would only get worse. Surprisingly, things may recover in a way no one ever saw coming.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.