“Accept the challenges so that you can feel the exhilaration of victory.” – George S. Patton
I hope everyone enjoyed Thanksgiving. For me, it was a welcome break from the volatility in markets, which in just two short weeks has resulted in a significant decline in stocks. I noted that following the first week of November, our ATAC (Accelerated Time And Capital) models positioned are clients largely into “risk-off” mode, i.e. mostly out of equities and back into U.S. Treasuries following the October melt-up. It appears that the timing of such a re-allocation was on target given recent volatility in equities. While November tends to be a favorable month for stocks, our models sensed an abrupt deflation scare was coming, and it appears the Italy and now Spain are the source of it.
I want to stress something which is very important for our clients and prospective clients to understand. Our ATAC models are quantitatively driven and are designed to answer two questions. The first question is whether we should be risk-on (equities) or risk-off (bonds) based purely on price inputs which gauge whether inflation expectations are rising (good for equities/bad for bonds), or falling (the opposite). The second question is how to best maximize time in outperforming ETFs within those asset classes. Risk-off does NOT mean to go into cash, and does not mean no-risk. Quantitative strategies that rotate across equities and cash have been shown to generally underperform buy and hold, while those that rotate across asset classes with low correlation to each other tend to perform considerably better.
Having said all that, last Friday our models positioned us full risk-off (into bonds) and out of all equity exposure as internals continued to deteriorate. A true feeling of deflation is taking hold, and no amount of Holiday spending can counter that. I have noted that Italy changed everything in terms of the continuation of the Fall Melt-Up, and it appears that my writings timed with ATAC were correct given that equities just had their worst Thanksgiving week since 1932. This occurred while 2 and 5-year Treasuries hit all time record low yields at recent auctions.
Do not underestimate how much lower yields can go here in the U.S, particularly if Europe is unable to put the fire out in the next few weeks. The world is in danger mode, and that means Treasuries can continue to experience strong demand as the world’s only safe-haven (ignoring Gold for this discussion). And while it is certainly possible that markets can rally on some kind of news or rumor, I don’t believe a sustainable uptrend in equities can occur unless we have the 3 Cs: confidence, competence, and certainty.
The fundamental problem is magnitude and speed. Italy was never a surprise – the speed at which interest costs rose (overnight) is. Every time worldwide equity markets go down 2%, something like $200 billion gets erased (depending on data sources – the number itself is less important than the general magnitude). Think about this for a moment. In a single day hundreds of billions of dollars can literally evaporate, and yet Europe with its massive debt is unsure about printing money to inflate out of it. Even if they turned the printing presses on at full speed, would it even matter? It seems to me they would need to print just to buy more printing machines in order to counter market movement.
So we wait and see how this plays out. It appears that U.S. bonds can continue to do well. At the end of the day, even if the Fed does initiate some form of stimulus/QE3, it likely would come in the form of more asset purchases, including the buying up of bonds. Equities would likely rally on this, but so would Treasuries. And again, it remains to be seen if such a program would inspire competence, confidence, and certainty longer term.
Going forward, I will try to include a list of all my writings for the week (see below) for those interested in my more traditional analysis and interpretation of intermarket relationships. I continue to believe we are headed for a “December to Remember Breakdown” in equities which could result in a repeat of August/September (though admittedly the most recent action of equities is making that prediction come to pass early). With the U.S. dollar rallying strongly, all signs point to the early stages of a panic. Fortunately, our ATAC models have been tested in the worst decade since the Depression, allowing us to tactically navigate through some incredibly rough waters.
Michael A. Gayed, CFA
Chief Investment Strategist
Pension Partners, LLC
Summary of Writings Published Last Week:
The ‘December to Remember Breakdown - http://www.marketwatch.com/story/the-december-to-remember-breakdown-2011-11-25?link=MW_TD
Fear Premium in Oil Starting to Wane - http://www.marketwatch.com/story/fear-premium-in-oil-starting-to-wane-2011-11-23?link=MW_TD
Financials and the December to Remember Breakdown - http://www.minyanville.com/businessmarkets/articles/price-ratio-October-relative-lows-Financial/11/23/2011/id/38059
Retail ETF Leadership Wanes as Deflation Scare Persists - http://www.etftrends.com/2011/11/retail-etf-leadership-wanes-as-deflation-scare-persists/
Small-Caps and the December to Remember - http://seekingalpha.com/article/309649-small-caps-and-the-december-to-remember
Silver and the December to Remember - http://seekingalpha.com/article/309721-silver-and-the-december-to-remember
Emerging Markets May Have a Scary December to Remember - http://seekingalpha.com/article/309939-emerging-markets-may-have-a-scary-december-to-remember
Bond/Stock Relationship Echoing 2008? - http://www.ritholtz.com/blog/2011/11/bondstock-relationship-echoing-2008/
ATAC Backtested Model Results:
ATAC - Conservative Model Backtested Results:
ATAC - Moderate Model Backtested Results:
ATAC - Aggressive Model Backtested Results:
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.