“Continuous effort – not strength or intelligence – is the key to unlocking our potential.” – Winston Churchill
Following unrelenting declines in the weeks prior, the S&P 500 underwent an unrelenting advance off of the mid-October lows. Equities shrugged off any and all kinds of news, with the bottom occurring on central bank jawboning that the pace of Quantitative Easing could slow. The move was reminiscent of prior V-shaped formations, but from considerably deeper oversold levels. However, into the strength in overall beta, defensive sectors did not meaningfully underperform, and Treasury yields did not rise commensurate with the excitement in stocks. In other words, there was still enough rolling strength in defensive areas to suggest that the decline may not be over yet.
The thing with every V formation is that you never really know if it is a V to push for higher highs, or a W. Quantitative Easing is slated to end next week, which will likely bring with it some new intermarket movement. While tempting to chase the rip higher and to think “that was it,” we must stick to our quantitative models in our separate accounts and mutual funds for both our alternative inflation rotation strategy and our equity, long only beta rotation strategy using inputs referenced in our two award winning papers. The good news remains that intermarket trends are acting considerably more normal and that the correlation between stocks and Treasuries, and defensive sectors/cyclical sectors is breaking. For a tactical methodology like ours which goes aggressively conservative and performed extremely well during the major part of the decline, that’s a positive thing.
Should the market want to make a push for new highs, seasonality wise it would make sense given that we are now entering the “best 6 month” period for equities, whereby stocks tend to do well. If that is the case, then our inflation rotation strategies may be set up for a trade in small-cap stocks which have badly lagged and may be due for some mean reversion. The extra leverage that strategy employs means a significant move higher could occur for the portfolios adhering to that model should ratio leadership take hold. On the equity side, cyclical sectors could begin to show outperformance relative to defensives, which for the bulk of the year have been what has held large-cap indices up.
The underlying problem with this environment remains the disconnect between stocks and inflation expectations, now a global problem with Europe one shock away from Japan-style secular deflation. That, combined with Retailer stocks underperforming might also mean that seasonal patterns get thrown off, and that the correction is not over yet. Should the Ebola scare worsen, it may at the margin result in less Holiday spending which may be what retailer stocks are anticipating. Regardless, for us we maintain our discipline and our belief that long-term probabilities matter within the context of two strategies, one absolute, and one equity, which are unique and have the potential to be true diversifiers in portfolios.
Michael A. Gayed, CFA
Chief Investment Strategist
Pension Partners, LLC
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.