A Different Kind Of Great Rotation?

| About: SPDR S&P (SPY)

"There is no standing still because time is moving forward." - Greg Lake

U.S. stocks closed mixed last week as the S&P 500 (NYSEARCA:SPY) ended flat while the Russell 2000 (NYSEARCA:IWM) fell slightly on what appears to be a stalling out of the U.S. centric bull market of 2013. Better economic data on the housing side with new home sales rising to a 5 year high does not seem to be translating through to Homebuilder stocks, which closed down on average 3.8%. Higher gas prices, slowing refi activity, and a bump up in initial jobless claims may serve as major headwinds going forward which Homebuilder stocks (NYSEARCA:XHB) are paying attention to, as U.S. broader markets continue their honey-badger-don't-care ways. Against this backdrop, Europe manufacturing expanded for the first time in two years, while China's fell to an 11 month low. Europe (NYSEARCA:VGK) ended the week on average up 1.15%, outpacing the U.S. on that better than expected news. China (NYSEARCA:FXI)? Ahead by 2.9% on worse than expected news.

Last week may mark a major change in mentality. Ignoring Japan (NYSEARCA:DXJ) for the moment, the U.S. has been the standout performer in 2013, as pretty much everything else around it has lagged badly and performed more in line with historical behavior during deflationary pulses, which have defined the year based on intermarket trend movement. The "Great Rotation" out of bonds seems to be going more into cash rather than stocks, while money may be on the verge of rotating away from domestic equities and more towards international ones. For us and our ATAC models used for managing our mutual fund and separate accounts, we positioned into emerging markets given improved relative momentum, and price behavior.

Whether the move into emerging markets will last or not remains to be seen. As I noted in my Marketwatch writings last week, the U.S. market is historically very overbought given the pace of the advance. Emerging markets, on the other hand, are lagging by the most since 1998 when an actual crisis and event took place. No such scenario has played out in 2013, indicating a significant overreaction in performance differentials. Any kind of mean reversion, which may be about to begin, could result in hefty gains for those areas of the stock market overseas which have not participated in the U.S. rally. To simply get back to the ratio level of mid-May when the taper spasm began, emerging markets would have to outperform the U.S. by about 1000 basis points. I have been very purposeful in saying the emerging market trade is the "next fat pitch" - for us, we are now taking a swing.

The ultimate question all year has been "who is right?" The U.S. stock market has run away without fear of deflationary headwinds, while everything else has been muted. The length of time that emerging markets in particular have performed poorly, combined with the focus on the Dow, likely makes any trade there a good contrarian call. Even if U.S. markets were to begin a correction, there is considerably more cushion in Brazil (NYSEARCA:EWZ), Russia (NYSEARCA:RSX), India (NYSEARCA:INP), and China (NASDAQ:PGJ) given their negative year to date performance and cheaper valuation ratios than the comparatively more extended U.S. That means it is entirely possible they could generate gains and buck any downward pressure that could come from concerns over housing that investors in homebuilder stocks seem to be expressing.

This has been an odd year for anyone who did anything other than a leveraged buy and hold position in the U.S. market. I caution on thinking such a strategy works going forward, especially from an opportunity cost perspective of rotating to areas which have more upside potential. The expression "you are only as good as your last trade" is nonsense. You are only as good as your process. We have full faith in our backtested inflation rotation strategies, and remain excited for how the remainder of 2013 could play out.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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.

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