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Week in Review - November 6, 2011

“Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.” – Karl Von Clausewitz
Following one of the best October’s on record for risk assets, November started off pretty much with a thud. Between news of MF Global’s bankruptcy and the bipolar nature of Greece’s politics (from risk-on/risk-off to referendum-on/referendum-off), markets closed lower for the week as a fresh injection of uncertainty over Europe made investors question whether the October rally was justified. The media of course loves to focus on the next major headline, even if it hasn’t been created yet. So what about Italy now? Portugal? Nothing like continued fear to bring ratings up.
Markets internally appear to be unclear given all this, as investors perhaps are sensing a period of near-term vulnerability. Our ATAC (Accelerated Time and Capital) models picked up on this, resulting in our positioning out of nearly all equity exposure again and into bonds this past Friday across the board. The risk-off signals are not as strong as they were at the end of July before the August and September declines occurred, so it may simply be a very short-term switch. As followers of my writings will note, I continue to press on the theme that markets will continue their “Fall Melt-Up” into the end of the year barring some kind of exogenous event, which market internals are not sensing just yet.
The conditions more broadly still favor a “risk-on” position as the more intermediate trends still point towards rising inflation expectations.  However, as I have noted before – I try to put a spotlight on what my approach to intermarket analysis suggests the message of the markets is. In other words, I stress the “what” the market is addressing, while our ATAC models are more precise in terms of the “when.” I do suspect that we will be switching back into equities, but for now it appears as though the models are not as certain on the coming days.
Meanwhile, hedge fund performance for October is starting to trickle out, and results seem to be sub-par. I have noted before that the October move up was so violent because few were expecting it, which subsequently means only the most nimble of traders and active managers were capable of capturing it. Our models positioned us into equities all-in after the first full trading week of October, allowing us to capture the bulk of the upside move when few others did. We believe that one of the strengths of our weekly models is that it allows us to quickly reallocate as conditions change underneath the market’s surface.
What is throwing the model into defensive mode now is a combination of sector and cap performance. While on the one hand high beta small-cap stocks and emerging markets broadly speaking continue to show signs of early outperformance, there has been a tick up in strength in defensive sectors such as Utilities, Healthcare, and Consumer Staples.  Bonds have also rebounded sharply off of their relative lows hit in late October.  Effectively markets seem to be going through a tug of war, where on the one hand the right equities for risk-taking are outperforming, but the wrong sectors are showing strength at the same time.
On a more personal note, I am humbled by the kind words of Marc Faber of the Gloom Boom and Doom Report. I have contributed to his Monthly Commentary before, and in his most recent one in which I make the case for the return of inflation (expectations), he specifically wrote about me that “so far, his timing about market moves has been impeccable.” I certainly know that I will get many things wrong about market direction and conditions, as all market prognosticators do. However, investing is always about probabilities and never certainties. In all of my writings, I focus on the idea that the conditions favor a move in a particular direction for risk-taking. The conditions of course do not guarantee it, but just make the likelihood higher.
So far this year, the message of the markets has been loud enough for me to hear and to bring attention to readers of my writings. For those who have not read the actual writing Marc Faber published of mine last week, I happened to find a spot where someone else uploaded it: I have received positive feedback from people I have never met who discovered me through Mr. Faber writings. Given my conversations and interactions with followers of my thinking, I have decided to follow in my father’s foot steps and write a book detailing my approach to intermarket analysis.  I have mentioned before that my father worked alongside legendary Bob Farrell in the late 80’s and wrote a book published in 1990 on integrating fundamental, technical and economic trends.  Its time for an update.
I want to stress that unlike other analysts of Strategists, I try not to fall too much for the “narrative fallacy” of explaining why markets move the way they do.  It is certainly important to always ask if price ratio levels are justified, so long as there is a recognition that what I think about what’s going on in the world really doesn’t matter.  What matters is what Mr. Market thinks. After all, the only thing that matters is not my opinion, but the opinion of the person I’m selling to.  It’s that person that sets price.
Having said all that, I will say that from a behavioral standpoint, there are several studies that show that human beings have very narrow confidence intervals.  In other words, we tend to underestimate scenarios beyond our understanding.  We also tend to underestimate how long things can go on for.  I suspect that it will take much longer than one might think for Europe to get out of its mess, with continued fluctuations along the way.  This is not inconsistent with the idea of markets still pushing higher – it simply means that one’s appetite for volatility likely has to increase because its being forced upon us in ever-growing quantities.
We will be updating our ATAC Composite Performance Profiles in the coming weeks. Our strategies continue to perform well given the difficult nature of this year’s markets.  In addition, in an effort to continue to provide followers of our thinking with new ways of tracking us, we are on the verge of launching our own YouTube show which will feature weekly videos of our analysis on markets.  Between my writings and these videos, our objective is to bring more attention to our firm and investment management strategies.
As always, we are excited for the future and look forward to continuing to show how ATAC performs.
Michael A. Gayed, CFA
Chief Investment Strategist
Pension Partners, LLC
Twitter: @pensionpartners
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.