ATAC Week In Review: The Source Of Complacency And Coming Fear

Includes: SPY
by: Michael A. Gayed, CFA


Talking about a correction is not the same as preparing for one.

Source of risk is junk debt.

No one is asking when they should be selling high yielding debt.

"Never be afraid to sit a while and think." - Lorraine Hansberry

Over the last several days, I've had the pleasure of presenting for the CFA Institute, Market Technicians Association, and several investment advisory offices our award winning papers on predicting stock market volatility and corrections. I have interacted with those in the business, and debated about the current state of markets. Universally, there does appear to be an underlying tone of negativity and skepticism about US stocks (NYSPY) continuing their manic rise in the face of clear negative signaling Treasuries are expressing. Yet, as concerned as these fiduciaries seem to be, few are acting to fix the roof before it rains.

Several advisors noted that their clients in recent weeks have been asking "when should I sell my stock?" This in turn has made those advisors worried about being blamed for taking a potential dip lower in portfolio values. I had a particularly interesting discussion with one advisor who noted that from a contrarian standpoint, one could argue this is bullish. After all, markets have a habit of climbing a wall of worry, and markets tend to trend higher when individuals are afraid of stock declines.

My response to this point was that he was right in his thinking. Yet, how many of his clients are asking "when do I sell my junk debt, my high yielding investments?" The answer? None. The source of all complacency and coming fear in the stock market is not the stock market. The greatest source of risk now is in junk debt, with yields so low that it suggests investors have forgotten what default premiums are. To be contrarian does not mean to only look at equity market sentiment, but rather sentiment up the capital structure. The reach for yield is the source of all fragility now, precisely encouraged by the Fed, and now at extreme and dangerous levels.

As to our mutual funds and separate accounts, we did a risk rotation last week. Something is legitimately disturbing with the way long duration Treasuries are behaving. They are in some ways acting as if a negative event is about to unfold. Now clearly Treasuries can be wrong about the future, but they tend to probabilistically be more right than wrong. With rolling 6 month correlations between stocks and Treasuries at extreme positive levels relative to history, we are truly on the verge of something breaking. Either stocks will break down, or Treasuries will. Both cannot be right for an extended period of time in their completely opposite views of future economic growth and inflation.

From April to May 2012, long duration Treasuries outperformed the S&P 500 by a whopping 3000 basis points (30%) in two months. Its time they start staging such a move once again.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has 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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