“Every end is a new beginning.” - Anonymous
It was one of the most volatile years for markets in history, and a far more challenging environment for active managers than 2008. The world came close to the edge multiple times following the Summer Crash of 2011 as fears flared over a Lehman-like event in Europe and a disintegration of the European Union. Improving economic data in the U.S. was not enough to calm investor concerns, as volatility soared with a number of unprecedented daily moves happening week to week. Since August 1st, the average daily difference between intraday highs and lows was 269 points on the Dow Jones Industrial Average. Legendary hedge fund managers and traders with impressive track records significantly underperformed the S&P 500 which closed the year flat, while European and Emerging Market indices were down substantially in the double digits.
And yet, it was ultimately the Fed that defined 2011. Consider the following:
1. The absolute best week for Treasuries bonds in 2011 occurred the week of 9/19 (+7.66%), when the Fed announced Operation Twist. It was also the worst week for equities since 2008.
2. The absolute best week for the S&P 500 in 2011 occurred the week of 11/28 (+7.32%), when monetary authorities surprised markets through coordinated central bank action. It was also the best week for equities since 2009.
And what about the media's constant talk of “risk-on/off?” If you define risk-on as equities, and risk-off as bonds as ATAC does, then consider the following:
1. Risk-Off: The biggest weekly performance spread differential between risk-on/risk-off (stocks/bonds) occurred the week of 9/19, when Treasuries outperformed the S&P 500 by a whopping 1,422 basis point (14.22%)
2. Risk-On: Of the three best weeks where equities vastly outperformed Treasuries, the 2nd and 3rd biggest spread differentials of the year occurred on the weeks of 6/27 (when the Fed officially ended QE2), and 11/28 (Global Central Bank intervention), with the S&P 500 outperforming Treasuries by over 870 basis points (8.7%).
Across all of our ATAC strategies, we were positioned in equities the week of 9/19 as our models said to go “risk-on.” We were exposed to what ended up being the worst week since 2008 in equities on the Fed's Operation Twist announcement. Its worth noting that going “risk-on” was actually correct, just early given the immense move up in October for equities which we repositioned for. Our strategies went full risk-off the week before global central banks intervened (week of 11/28), as we missed the big up move. Again, its worth noting that the environment was significantly negative enough making ATAC correct; it was that very negative environment which forced monetary intervention.
While our ATAC strategies did disappoint compared to historical backtesting, we know factually that the reason for this has to do with two extreme weeks which came about from being on the wrong side of the risk-on/off trade and which were entirely defined by Fed action responding to European financial stress. We also know that when compared against hedge fund performance, the results are competitive given the environment active managers were operating in last year.
Having said all that, it’s a new year. I noted in last week’s “Lead-Lag Report” available on Minyanville.com that 2011 ended on a deflationary note with market internals quite weak. I personally started off the year negative on equities given how 2011 closed. It appears a complete 180 has occurred now. There was dramatic internal improvement in markets despite the S&P 500 being up only slightly in the first four trading days of 2012. Defensive sectors relative to more cyclical areas of the market substantially weakened, volatility remained low, and bond yields began to slowly creep up. All of this is extremely bullish and is the first real sign that markets may be in the process of a “Winter Resolution” whereby a trend asserts itself. With confirmation last week, our ATAC models went full risk-on into equities. I expect the next few weeks will see more aggressive risk-taking into higher beta areas of equities as further strength expresses itself. Ed Dempsey discussed some of this in our most recent video update, available at www.youtube.com/pensionpartners.
But wait a minute, what about Europe? Consider that by now, everyone knows about Europe and investors have likely discounted bad news. In addition, I believe the likelihood now is for a positive surprise rather than a negative one. And yes – as I have written about over the past few months, the world needs a much weaker Euro. As the Euro has declined and our U.S. dollar has risen, our equity markets continue to be resilient. A weaker Euro benefits European exports, which in turn will ease the debt burden of various countries in the Eurozone through the inflationary effects of a weaker currency. Let us not ignore also the very real possibility that here in the U.S., housing appears to be improving substantially. All of the liquidity measures of the Fed and the European Central Bank appear to very suddenly be making an impact. Much like a ketchup bottle which you keep shaking, very suddenly when its not expected, the ketchup (inflation expectations) coat the plate.
As such, we are encouraged by how 2012 has started, and expect more normalcy to occur within the market. It is tempting to believe this will NOT happen given 2011’s market performance. This is natural – in psychology the “recency bias” is the idea that people put heavier weighting on recent data, and extrapolate that into the future as if the recent past is reflective of the near future. The problem with that of course is that when you extrapolate what is factually an outlier year of results, you miss out on a period more indicative of average environments.
2011 was in many ways an outlier even from ATAC's standpoint. We remain fully confident in our strategies and believe we can offer investors a true hedge fund alternative which is transparent, highly liquid, and fee skinny. Thank you for your continued interest in Pension Partners, and please feel free to reach out to us anytime.
Summary of Writings Published Last Week:
The Lead-Lag Report: A New Beginning for Risk? - http://www.minyanville.com/businessmarkets/articles/utilities-sector-utilities-heathcare-health-care/1/3/2012/id/38651
Don’t be Fooled by the Silver Boost - http://www.minyanville.com/businessmarkets/articles/silver-equities-precious-metals-ishares-silver/1/4/2012/id/38683
2012 – Year of the (Regional Banks)? - http://www.minyanville.com/businessmarkets/articles/banks-regional-banks-banks-2012-consumer/1/5/2012/id/38706
How a Weak Euro Became Bullish - http://www.minyanville.com/businessmarkets/articles/euro-dollar-us-dollar-summer-crash/1/6/2012/id/38730
The Need vs. Want Trade - http://www.marketwatch.com/story/the-need-vs-want-trade-2012-01-04
Ending 2011 on a Deflationary Note - seekingalpha.com/article/316918-ending-2...
Reflation Breakout and the Winter Resolution of 2012 - seekingalpha.com/article/317368-reflatio...
Financials, Bullish Sentiment, and the Winter Resolution of 2012 - seekingalpha.com/article/317763-financia...
Europe, Inflation Expectations, and the Winter Resolution of 2012 - seekingalpha.com/article/317944-europe-i...
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.