Michael A. Gayed's  Instablog

"A lot of my work is a matter of reacting to surprises in life." - Alexander Wang

Rather remarkable how bad it feels out there, with the S&P 500 having an incredibly strong year of performance, isn't it?

Stocks continue their Summer Surprise, nearing the year's all-time highs as bonds begin to crack amidst what I believed would be the coming "end to the end of the world trade" I wrote of as my seasonal call in late June (http://www.marketwatch.com/story/the-end-to-the-end-of-the-world-trade-2012-06-20). Many have been arguing that the rally is finished, but I wholeheartedly disagree given that various intermarket trends are still very early in their bullish infancy. I have argued since the low of June 4th that another stock melt-up was likely, and I maintain the reasoning behind it (http://www.marketwatch.com/story/the-end-to-the-end-of-the-world-trade-2012-06-20). With so few having participated in the rally to begin with due to the strength of the negative narrative, the potential for money to chase rising stocks is increasing by the day.

What is most telling about the most recent price action in markets is the behavior of the cyclical trade, which as I have noted for the last two weeks is signaling a melt-up may be upon us (http://www.minyanville.com/business-news/markets/articles/michael-gayed-lead-lag-report-energy/8/1/2012/id/42858). Across the board it appears that those areas most sensitive to global growth expectations are beginning to lead, as Materials, Energy, Industrials, and Emerging Markets show signs of life again. This, combined with small-cap stocks which began to dramatically strengthen shortly after my article pointing out that they reached a "pre melt-up extreme" (http://www.marketwatch.com/story/small-caps-reach-pre-melt-up-extreme-2012-08-06?link=MW_latest_news), is all how a meaningful rally begins.

While the world now waits for definitive action by the European Central Bank, I think the more interesting story will be what policy actions are taken by China. With year over year inflation in the world's second largest economy having its slowest rate of gain since January 2010, it makes sense that the monetary and fiscal side have an excuse to stimulate. This may ultimately be why metals are showing interesting price behavior in the last week, alongside strength in China's ADRs themselves. Our ATAC (Accelerated Time And Capital) models are sensing this, and remain fully exposed to equities.

Despite the negative narrative, the bullish call we have been expressing has factually been the right one all year, and we are excited for the next wave higher. It appears that the timing for our mutual fund launch in September to be offered alongside our separate account composites could very well be ideal for us as a firm as we work towards providing a true buy and rotate investment approach which has never been done before in the way we are doing it.

And that's exciting.

Sincerely,

Michael A. Gayed, CFA

Chief Investment Strategist

Pension Partners, LLC

www.pensionpartners.com

Twitter: @pensionpartners

YouTube: www.youtube.com/pensionpartners

Summary of Writings Published Last Week:

The Lead-Lag Report: Melt-Up Redux - http://www.minyanville.com/business-news/markets/articles/xle-xli-tip-ief-xlu-utitlies/8/7/2012/id/42994

Europe to Bears: You're Wrong - http://www.minyanville.com/business-news/markets/articles/VGK-IVV-s2526p-gayed-vgkivv-technical/8/9/2012/id/43072

Small-Caps Reach Pre-'Melt-Up' Extreme - http://www.marketwatch.com/story/small-caps-reach-pre-melt-up-extreme-2012-08-06

Copper Melt-Up Coming as Miners Reflate - http://www.marketwatch.com/story/copper-melt-up-coming-as-miners-reflate-2012-08-08

Metals Surprise on Inflation's Return - http://www.marketwatch.com/story/metals-surprise-on-inflations-return-2012-08-10

Spain V Takes Shake and It's Bullish - http://www.forexpros.com/analysis/spain-'v'-takes-shape-and-it's-bullish-132130

The Aussie Dollar/China Market Connection - http://realmoneypro.thestreet.com/articles/08/07/2012/aussie-dollarchina-market-connection

The Bond Message Gets Louder - http://seekingalpha.com/article/794411-the-bond-message-gets-louder

Time for a Coalback? - http://seekingalpha.com/article/800891-time-for-a-coalback

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.

"Disappointment is an endless wellspring of comedy inspiration." - Martin Freeman

Markets were highly volatile last week as the world waited for monetary policy announcements from the U.S. Federal Reserve and European Central Bank, both of which "disappointed" by not enacting any new policy measures. Yet, despite more continued rhetoric without action, stocks actually closed the week positive, holding on to gains made the week prior. I noted on Twitter (@pensionpartners) that market internals all week kept on improving in the face of doom and gloom coming from the media, as defensive sectors all began breaking down and bond yields began to rise.

On Monday I co-hosted Bloomberg reiterating the bullish case for stocks (http://www.bloomberg.com/video/reflation-coming-buy-stocks-says-gayed-ZxI9ikrXQRapfaH3KbGE9w.html) as well as the "Summer Surprise" (http://www.bloomberg.com/video/bonds-to-stocks-summer-surprise-in-august-jaMmAXN4SmiknEwyER0k6Q.html). On Thursday as stocks were faltering, I noted on CNBC that internals were "deceptively bullish" (http://www.cnbc.com/id/15840232/?video=3000106914&play=1) despite worldwide panic over Draghi's speech. Friday, markets undid the entire decline generated from Monday-Thursday.

Why did markets behave in such a volatile way? First, as much as media pundits argue that it was a major negative that no new policy action was taken, I take a completely different approach to this. The European Central Bank is doing PRECISELY what it needs to do, which is to remind investors that in their paranoia over a 2008 repeat, they will do whatever it takes to preserve the Euro. How can this be done in the face of Spanish bond yields which are near a tipping point? I believe the likely course of action will ultimately be an implied cap on interest rates, such that the ECB buys bonds of Spanish and Italian debt when a certain ceiling is hit. This keeps the pressure on those governments to continue austerity, but also takes off the risk of contagion through a complete buyer strike and the effects of that. This is why the VIX (a volatility gauge which tends to do well when fears over an event are rising) sold off on Thursday and Friday in an aggressive way.

I expanded on this idea Thursday morning in a lengthy interview as the news crossed in a segment which can be seen at http://www.youtube.com/watch?v=EOLcshzr3lw&feature=plcp. Prevent the event, and the perception of a 2008 repeat, and the re-allocation from bonds to stocks likely takes place as money begins to take risk again. Inflation expectations based on various intermarket trends are unquestionably beginning to show signs of life again, which is a bullish environment for equities. Our ATAC (Accelerated Time And Capital) models remain fully allocated to stocks, and have only turned more bullish following last week's market action. Few are fully prepared for what could be a runaway move in stocks given the strength of the negative narrative, which as I argued in a bull/bear debate is too priced in to be right (http://www.bloomberg.com/video/uber-bull-vs-uber-bear-where-is-the-market-going-1kHY5BBZQSG~g~jpnQnKZA.html).

We remain bullish as a repeat of the Fall Melt-Up of 2011 appears likely in the near-term. I have argued since June 4th that another such move was likely, and maintain the idea that stocks can experience an "inverse Summer Crash." With sell-side analysts the most bearish on stocks since the 1980s, AAII sentiment surveys showing continued pessimism, and absolutely no belief in equities despite them being up over 11% year to date, this seems like the contrarian investors dream environment to make a bet where no one else is betting: equities.

We continue to push forward at Pension Partners, preparing for the launch of our mutual fund in September to be offered alongside our separate accounts. The countdown is on, and we are excited to provide investors with a strategy that has never been done before in the way we are doing it.

Until then, we'll simply keep the pressure and stand by our message or what the market is saying.

Sincerely,

Michael A. Gayed, CFA

Chief Investment Strategist

Pension Partners, LLC

www.pensionpartners.com

Twitter: @pensionpartners

YouTube: www.youtube.com/pensionpartners

Summary of Writings Published Last Week:

The Lead-Lag Report: Cyclical Melt-Up Coming? - http://www.minyanville.com/business-news/markets/articles/michael-gayed-lead-lag-report-energy/8/1/2012/id/42858

Energy to Deflationists: Pay Attention - http://www.minyanville.com/business-news/markets/articles/reflation-trade-energy-sector-energy-stocks/8/1/2012/id/42885

Inverse Summer Crash Takes Place - http://www.marketwatch.com/story/inverse-summer-crash-takes-shape-2012-07-30

Silver Set to Rally Amid Forced Reflation - http://www.marketwatch.com/story/silver-set-to-rally-ahead-on-forced-reflation-2012-08-01

The Most Important Charts in the World - http://www.marketwatch.com/story/the-most-important-charts-in-the-world-2012-08-03

Silver Miners to Love Reflation - http://www.forexpros.com/analysis/silver-miners-to-love-reflation%20-131706

Despite It All, VXX at New Lows - http://www.forexpros.com/analysis/despite-it-all,-vxx-at-new-lows-131955

Emerging Market Currencies Continue Risk-On Trade - http://realmoneypro.thestreet.com/articles/07/31/2012/emerging-market-currencies-continue-risk-trade

Euro Bounce in the Cards - http://realmoneypro.thestreet.com/articles/08/05/2012/euro-bounce-cards

Did Draghi Flip the Spring Switch? - http://seekingalpha.com/article/759621-did-draghi-flip-the-spring-switch

Junk Debt/S&P 500 Switcheroo - http://seekingalpha.com/article/781441-junk-debt-s-p-500-switcheroo

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.

"Perpetual optimism is a force multiplier." - Colin Powell

Stock markets closed up nicely last week with the bulk of gains directly attributable to strong rhetoric coming out of the Mario Draghi of the European Central Bank re-assuring the world that the central bank would do whatever it takes to preserve the Euro. As we've seen with many prior times in terms of market reaction, central bank paranoia is bullish for risk assets as it reminds the world that monetary authorities will try to front-run the possibility of a Lehman-like event and 2008 repeat. Rumors circulated around a potential bond buying program similar to what the Federal Reserve has done in its Quantitative Easing program, but it is unclear if this is the ultimate course of action the ECB will take.

Regardless, it is becoming more clear that preserving the Euro means preserving the European Central Bank. If Spain goes, the Euro goes, and the ECB goes. To simply keep his job, Draghi likely has to do something aggressive to counter Spain's rising debt yields. I made a big point about this on various CNBC segments I did last week, available by searching my last name on www.CNBC.com and on www.youtube.com/pensionpartners. Remove the perception of the event risk, and rally on. One way to do this would be to do a partial bond buying program that would cap how high Spanish bond yields go such that the pressure is still on the government to cut spending, but also not send the entire financial system into a tailspin.

Our ATAC (Accelerated Time And Capital) models used for managing client accounts re-positioned into stocks as market internals improved. As I have stated before, it is unclear if this is a false positive or not, but it makes sense to assume that markets can now strongly move to new highs on the year. The S&P 500 is up over 11.5%, and the Dow Jones Industrial Average has retaken the 13,000 level. Bond yields are still far below rates of inflation, and dividend yields for nearly all sectors of the stock market makes stocks a better income play than bonds. If this move is real, then the next rotation likely occurs into emerging markets and those areas more sensitive to a return to growth expectations.

If reflation does not happen organically, then it is clear that central bank paranoia will try to force it upon us. As an interpreter of market conditions and inflation rotation manager, everything I focus on is not about whether such measures are "right" or "wrong" - this is the environment we live in. To generate returns, it is crucial to anticipate the anticipation of others. If the market now begins to believe that more monetary action is coming to remove tail risk, then it will begin to act that way independent of whether actual policy is taken or not in the very near-term. I have long said that rising risk assets are now more stimulative than central bank action, and maintain that view. Where Draghi and crew can help is to remove the perception of event risk. That alone can cause markets to rally hard.

And so we enter August when last year's Summer Crash started, it is worth noting that the negative narrative is more mainstream now than it ever was before. The bear paradox has prevent a significant decline in stocks in the U.S., AAII sentiment surveys are showing significant bearishness, and bonds keep getting all the love. For all we know, August may be the money when central banks flip the delayed Spring Switch out of bonds and into stocks. If it is, a significant move higher in stocks may yet be waiting to appear among the line of white swans of negativity.

We continue to push forward, and are exciting for our upcoming mutual fund launch in September which will be offered alongside our separately managed accounts. August will be a busy month for us at Pension Partners, as we launch a new version of our website, and launch various other business initiatives. Finally, tune in to Bloomberg live at Bloomberg.com/tv between 3-5 PM EST when I will be co-hosting as I did on June 4th making the case for another melt-up in what happened to be the day of the low for stocks. Should be a good time as always.

Sincerely,

Michael A. Gayed, CFA

Chief Investment Strategist

Pension Partners, LLC

www.pensionpartners.com

Twitter: @pensionpartners

YouTube: www.youtube.com/pensionpartners

Summary of Writings Published Last Week:

The Lead-Lag Report: Reflation and Melt-Up Returns? - http://www.minyanville.com/business-news/markets/articles/xlb-xle-tip-xlp-xly-iwm/7/24/2012/id/42679

When to Fear an Oil Spike - http://www.minyanville.com/business-news/markets/articles/energy-stocks-xle-oil-crude-oil/7/26/2012/id/42750

Apple Competes with Treasury 'fearPad' - http://www.marketwatch.com/story/apple-competes-with-treasury-fearpad-2012-07-23

Did Apple Break the Market? - http://www.marketwatch.com/story/did-apple-break-the-market-2012-07-25

Central Bank Paranoia Returns - http://www.marketwatch.com/story/central-bank-paranoia-returns-2012-07-27

Fear Not the Euro - http://realmoneypro.thestreet.com/articles/07/25/2012/fear-not-euro

Draghi Could Break the Yen - http://realmoneypro.thestreet.com/articles/07/29/2012/draghi-could-break-yen

China Bull Market Returns? - http://seekingalpha.com/article/752071-china-bull-market-returns

Did Draghi Flip the Spring Switch - http://seekingalpha.com/article/759621-did-draghi-flip-the-spring-switch

Agriculture Strength Not Confirmed by Stocks - http://www.forexpros.com/analysis/agriculture-strength-not-confirmed-by-stocks-130842

Need Bears Want, and What it Means for Stocks - http://www.forexpros.com/analysis/need-beats-want,-and-what-it-means-for-stocks-130917

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.