"Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating." - Karl Von Clausewitz
Markets went through their worst week in 2012 as Eurozone fears flared again, U.S. jobs growth slowed, and China's economy expanded less than expected. In terms of Europe, Spain's 10-year bond yields neared the critical 6% level, reigniting concerns over the possibility that a bailout may be needed for the country in the very near-term. Credit markets were wobbly all week, with U.S. Treasury yields dropping again as investors feared another deflation pulse coming. In terms of jobs here in the U.S., payroll data disappointed, and confidence in the robustness of the recovery appears to be waning. While the Fed stands ready to stimulate the economy further, an expansion of asset purchases (QE3) seems to be a low probability scenario for now. As to China, growth numbers were less than expected, serving as a reminder that the world's second largest economy remains at risk of a "hard landing" scenario.
So yes - markets did have their worst week in 2012. But that does not mean it was a bad decline. Equities dropped somewhere between 1.5-2% as volatility picked up. I have addressed in several of my writings the idea that the odds of a correction are at their highest level this year, as our ATAC (Accelerated Time And Capital) models felt the deflation pulse beating again, positioning our clients largely into Treasuries out of the heavy equity exposure we had following the first week of January. That positioning served us well last week as bonds outperformed stocks. However, I maintain my belief that this likely will be a "mini" correction within the broader 2012 reflation theme.
The dilemma is clear for most investors. Yields are once again at panic levels while monetary authorities around the globe are focused on trying to spur inflation. In terms of the Federal Reserve, the explicitly target inflation rate of 2% means that buying a 10 year bond at 2% effectively results in no return. On the other hand, equities have rallied quite strongly so far this year, and are vulnerable to any kind of economic shock coming from overseas debt markets. Given that more is known now about Europe than last year, and that it is unlikely central banks will allow things to deteriorate because of the amount of effort spent getting to this place to begin with, it is difficult to see a scenario where everything begins to falter again as it did in the latter half of 2011.
Having said that, there is no doubt that there has been strong intermarket damage taking place, and that we are in a period of "risk-off" until some time passes for markets to digest news on the macro front. Our models are run on a weekly basis and can help detect when inflection points happen in terms of being exposed to equities or bonds. If the market can indeed act resilient and not drop substantially in the face of many reasons for us to correct in a deep way, then the post-correction environment likely would result in the "Spring Switch" occurring in earnest as investors bet against risk-free and bet on risk. As I said in a recent Bloomberg video interview (http://www.bloomberg.com/video/90464251/), there is only so much risk one can take in risk-free investments. We may be nearing that point very soon.
Michael A. Gayed, CFA
Chief Investment Strategist
Pension Partners, LLC
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Summary of Writings Published Last Week:
The Lead-Lag Report: Looks and Smells Like a Correction - http://www.minyanville.com/business-news/markets/articles/market-price-ratio-lead-lag-report/4/9/2012/id/40320
Why 2012 is EXACTLY like 2009 and the Spring Switch - http://www.minyanville.com/business-news/markets/articles/dia-dow-jones-industrial-average-stocks/4/12/2012/id/40396
The Role of Retailers in a Correction - http://www.marketwatch.com/story/the-role-of-retailers-in-a-correction-2012-04-09
Was that the Bottom in Gold - http://www.marketwatch.com/story/was-that-the-bottom-in-gold-2012-04-10
Stocks, Rocky Balboa, and Muhammad Ali - http://www.marketwatch.com/story/stocks-rocky-balboa-and-muhammad-ali-2012-04-12
Revisiting the U.K., QE3 and the Spring Switch - seekingalpha.com/article/484051-revisiti...
Betting on Resilience Through Regional Banks - seekingalpha.com/article/493161-betting-...
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.