Everyone Is A Weak Hand

“The one fact pertaining to all conditions is that they will change.” – Charles H. Dow, 1900

Well then – that’s one way to prove that conditions have changed.

You want to see markets that go down big?  Revisit Tuesday. Want to watch markets that go up huge?  Revisit Wednesday (which sucked a lot of the “buy the dip” crowd). Want to watch markets give it all back?  Revisit Thursday. Want to watch markets go up, down, up, and then collapse by the close?  Revisit Friday.

It has been my contention for the past several weeks that a Fall Epiphany was coming for markets, where risk mattered, and stocks would finally begin to price in the very real possibility of deflation which bonds have been screaming about all year. The Fall Epiphany has only just begun, as the Russell 2000 craters, global markets falter (particularly in Europe), and volatility emerges like the phoenix from the ashes of complacency. The roadmap that people followed in the outlier period of Quantitative Easing 3 will not help going forward. You can not navigate storms as if seas are calm.

The IMF continues to cut global growth, and Fed officials over the weekend, surprise surprise, are now arguing that a rate hike may be delayed because of a strong dollar Why apparently no one saw this change in tone coming is beyond me given the deflationary pressure a stronger currency has on a country. Nevermind that, however, given that rising rates for the Fed means nothing in the context of rising rates in the Junk Debt domain. On CNBC Friday I commented about the current state of markets, noting that there was the very real potential at some point for a Flash Crash repeat in equities if Junk Debt collapses. People forget that an hour before the Dow dropped 1000 points on May 6, 2010, Junk Debt had its own 1987-style crash. The real source of risk for equities remains potential panic selling to come in Junk Debt, punishing the bubble theme of searching for yield without regard for risk.

This is the kind of environment our ATAC strategies were built for. I was in Philadelphia earlier in the week presenting to the CFA Chapter there our award winning papers on predicting corrections and volatility using the signaling power of Utilities and Treasuries (http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=2224980). Someone during the Q&A noted that our research wasn’t really about taking risk. I said that was absolutely correct – everything we do is actually about when to LOWER risk pre, not post. Most people tend to hit the brakes after the crash, and not slow down entering the storm. The prolonged period of equity gains and tight correlations is ending, and may do so spectacularly given just how many weak hands there are. Recent sentiment data shows that suddenly, fear is dominating. One might argue that is a contrarian signal, and as such now stocks have to rise. However, the anchor is wrong. This volatility is absolutely nothing compared to what may be to come in order to resync equity sentiment to sentiment in nearly every other area of the investable landscape.

For our quantitatively driven, unemotional, academically sound and tested ATAC models, that means we continue to be exposed in the near-term to Treasuries which tend to benefit from equity gyrations in our inflation rotation strategies. For our equity sector beta rotation strategies, that means we continue to position all-in on Utilities, Consumer Staples, and Healthcare which were among the best performing sectors last week.

Stocks are not oversold. They remain massively overbought relative to growth and inflation expectations. That is not opinion – that is based on looking beyond the small sample to the large data set of time and market cycles. The time to Fight the Fed has come. Its time to remind traders and investors that mathematically, wealth isn’t generated by managing return, but rather by managing risk. If indeed this is only the beginning, watch our strategies, and seriously consider allocating to them. You may be shocked at how fast and aggressively we outperform our benchmarks because the very nature of our strategies is to go to the extremes of the defensive spectrum when conditions favor it most.

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.