ATAC Week in Review: The Future Is Not the Past

“Yesterday is a cancelled check. Today is cash on the line. Tomorrow is a promissory note.” – Hank Stram

Stocks in the US had their first positive week of 2015 as investors cheered what was already known to be coming – Quantitative Easing from the European Central Bank.  The 1.3 trillion dollar bond buying program, it is hoped, will reverse Europe’s deflationary funk and allow for a return to growth.  This predictably helped pushed European equities higher, as the German DAX index hit new all-time highs.  However, this is coming at the expense of the Euro, which appears to be in utter free-fall.  Similar to Japan, Europe’s strategy is to export deflation through a weakening currency.  The insanity of this, however, is that it has not helped Japan’s deflation problem, and no round of Quantitative Easing has ever been proven to boost reflation sustainably.

The meme currently out there is that Europe QE is bullish for US stocks, as the “baton” of stimulus is passed from Yellen to Draghi.  However, market action suggests otherwise.  If indeed European QE continues to break the Euro, with the Dollar already as high as it is, it stands to reason that European QE could actually be quite bearish for US multinational companies and their earnings due purely to currency volatility and trend direction.  This is a nuance being entirely missed by the media and investors/traders when thinking about asset allocation, regardless of whether QE in Europe actually works or not in terms of boosting the economy as opposed to stock animal spirits.

Something very special is happening in 2015 – the return of logic.  For the first time since the beginning of QE3 in the US, correlations appear to be reverting to historical levels.  Defense plays are actually playing the role of defense rather than offense, and “risk-on/risk-off” behaviorally seems to have returned.  Treasuries rally hard when stocks are volatile and fall, they then fall when stocks rise.  However, when Treasuries fall on those strong up days for stocks, they do not do so particularly violently, suggesting that finally Treasuries are serving as a proper hedge.  Our risk triggers have kept us in that part of the investable landscape in our alternative inflation rotation strategy which in three weeks has far surpassed most buy and hold averages across multiple asset classes.  The magnitude of being correctly positioned in such a juncture can far swell the frequency of being defensive through false positives.

In the case of our beta rotation equity strategy also used in our mutual funds and separate accounts, the three defensive sectors of Utilities, Healthcare, and Consumer Staples have performed as they should, outperforming in the rally meaningfully in a short period of time relative to more volatile cyclicals.  In my presentations done around the country (http://vimeo.com/115038674), I make it a point that alpha-generating strategies over long cycles do not generate outperformance by being up more, but rather down less.  There have been few opportunities to be down less than equities because of the smoothness with which large-cap averages have rallied.  One must assume the future is not the past, and that volatility in commodities, currencies, and bonds must soon filter to stocks.

We welcome that.  Most investors who buy “up and to the right” tend to do so near the turning point because they see a chart and extrapolate a trendline into the future.  They fail to take into account volatility around that trendline, and their ability to manage emotions that come from that.  For strategies like ours, whether alternative or equity, that volatility is the right kind of opportunity for active rotations.

Best,
Michael A. Gayed, CFA
www.pensionpartners.com

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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The Greatest Trick the Stock Market Ever Pulled

What if everything you thought was true about markets was a lie? That is the question everyone should be asking today.

It defies logic, but investors (if you can call them that) are now paying over 1% for the privilege of locking their money up in Switzerland government bonds for one year. You read that correctly: paying.

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Throughout history, we’ve been told that someone should pay you when you lend them money. Now you’re being asked to pay them. How can that be? Why would anyone do such a thing?

The only rational (if you can call it that) explanation is that investors are so afraid about the prospects for global growth that they’d rather pay to keep their money in a “safe haven” country like Switzerland than risk losing more money elsewhere.

The focus has once again shifted from return on your capital to return of your capital. But unlike 2008, investors are so concerned about the return of their capital that they are even willing to accept losing a portion of it (accepting a negative return).

Perhaps more alarming, investor fears aren’t limited to just the next year. Yields have gone negative in Switzerland as far out as 10 years.

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That’s right. For the peace of mind of owning Swiss government bonds, you have to pay 0.2% per year for the next 10 years.

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Now, if this backdrop wasn’t incredible enough, here’s where it really gets interesting. Rather than saying this is a troubling development for the global economy, most pundits are saying negative yields are a good thing.

Why? Because, we are told, it means additional central bank easing in the form of even lower rates and even more quantitative easing. And these easing measures (including the upcoming ECB QE), we are told, will continue to lift stock prices. And because we all know by now that short-term stock prices are an accurate representation the economy, the more negative the yields, the better.

I’m being facetious of course as the stock market is only the economy in the minds of central bankers. In the real world of slowing growth, stagnant wages, and a widening wealth gap the stock market is far from the economy. If it were, the economies of Europe and Japan would be booming with stock prices at new highs. Instead, Japan has fallen into its fourth recession since 2008 and Europe is not far behind.

The greatest trick the stock market ever pulled was convincing the world that negative yields are a good thing. How long will people fall for it? As long as stock prices are going up and the illusion of stability remains in place.

“You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time.” – Abraham Lincoln

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.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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Is the U.S. really decoupling from the world?

One of the key themes of 2014 was this notion that the U.S. was decoupling from the world. The narrative – Japan may be in recession, Europe in a deflationary collapse, and China slowing – but the U.S. is strong and is an island unto itself.

The narrative, though, is not the same as reality. While the U.S. economy has certainly fared better than its global peers, an “acceleration” we have yet to see, with real GDP still showing the slowest post-war recovery in history and real wage growth telling the same story.

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What, then, are investors basing their decoupling theme on? Very simply, the U.S. stock market, which to put it mildly has been trouncing its global peers since 2010. Five years of outperformance is a long time and enough to build a strong case for just about anything.

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If we look away from just the large cap stock indices, though, the U.S. story looks more like Europe and Japan than most investors may want to believe.

Falling Inflation Expectations

First, inflation expectations in the U.S. have been falling precipitously over the past year with breakeven rates (2-years through 30-years) back to their lowest levels since 2009.

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Yield Curve Flattening

Second, the yield curve in the U.S. is flattening, down to a 129 bps spread between the 10-year yield and the 2-year yield.

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Yields Plummeting

Third, like Europe and Japan, U.S. long duration yields have plummeted over the past year. The 30-year Treasury yield is at a new all-time low, below the crisis lows of 2008.

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Credit Spreads Widening

Fourth, credit spreads in the U.S. are widening, with the high yield index showing a 542 basis point spread, up from 388 basis point one year ago and 335 basis points last June.

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Defensive Sectors Leading

Fifth, within the U.S. stock market it is not cyclical but defensive sectors (Utilities, Health Care, and Consumer Staples) that have been outpacing the S&P 500 since the beginning of 2014.

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Leading Indicators Turning Down

Sixth, if we look past lagging indicators like GDP and focus instead on leading indicators, they are telling a different story.

The growth rate on the ECRI Weekly Leading Index has moved into negative territory, at its lowest level in three years.

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Similarly, the U.S. composite PMI Output index is showing its slowest rate of expansion in 14 months.

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Unprecedented Fed Action (0% Policy)

Lastly, the U.S. Federal Reserve continues to behave as if we are very much like Europe and Japan, holding interest rates at 0% now for over six years.

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Entering the year, many were predicting a rate hike by mid-2015, but the expectations for a Fed rate hike continue to be pushed out  as the stock market ticks lower. The futures market is now anticipating the first rate hike will not occur until October 2015 and we are not far from shifting to December 2015.

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The Decoupling Myth

Collectively, these factors suggest that the U.S. is not immune to a global slowdown. Indeed, it is already starting to feel the effects if we look at anything except the S&P 500. From easy monetary policy to plummeting yields and inflation expectations, the U.S. looks very much like its global peers. Moreover, the widening of credit spreads and outperformance of defensive sectors suggest that market participants are already starting to appreciate this and position accordingly.

What we have yet to see is large cap U.S. stock indices reflect this risk but as I wrote recently, that too may be changing here. Narrative follows price. If the v-bottom pattern that has persisted in the U.S. since the beginning of 2013 ends in the coming weeks, expect confidence in the narrative of “U.S. decoupling” to end with it.

At Pension Partners, our Beta Rotation and Inflation Rotation strategies remain defensively positioned.

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.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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