Bulls Give Thanks To A Single Word

"No duty is more urgent than that of returning thanks." - James Allen

The Dow Jones Industrial Average (DIA) and S&P 500 (SPY) rose as each ended the week above 16,000 and 1,800 respectively. Bond yields (TLT) moved higher for the bulk of the week before dropping Friday as continued back and forth taper trading occurs despite further on-going deflationary pressures in the developed world. US CPI fell month over month, and the 12 month rate is half that of the Fed's stated inflation target. Europe appears to be on the verge of enacting more "non-traditional" monetary measures, with negative rates being discussed by the European Central Bank. History has shown that stocks tend to not do well during periods of meaningful deflationary pressure and that bonds outperform. 2013 clearly has been a notable exception.

To that end, buy and hold US stock investors have much to give thanks for as we near Turkey day. This has been a powerful year for developed market equities and invested money if portfolios did not adhere to asset allocation. The source of this appears to be the word "taper" itself. Looking back at how 2013 year has played out, it is worth considering that the Fed manipulated emotions to force money into equities on the gamble that by uttering the word taper in May, money would rotate en masse out of bonds and into stocks. Last year I called this idea the "Great Re-Allocation" while this year the media has termed it the "Great Rotation." Fund flows have been increasing into equities since then as money became afraid that the Fed would no longer support the bond market.

The key thesis for the Great Rotation, however, was that reflation and increased growth would force money into stocks. The problem in 2013 is that there is no reflation, nor meaningful pickup in economic activity. If in December 2012, you knew with perfect foresight where growth and inflation would be by this time in 2013, there is an extremely good probability you would have chosen bonds over stocks as the preferred asset class. All logic, historical correlation and causation, and data pointed to this NOT being a year to favor beta risk, and yet here we are in awe with hindsight of how US equities have done. This, of course, makes it easy to think this was bound to happen. This year has been a statistical anomaly not only in terms of the gain in developed stock markets, but also in terms of yield behavior and the complete lack of participation by commodities and emerging markets.

Combine that with the fact that hedge funds on average are up a little over 6% year to date, and that moderate asset allocation portfolios are hovering around 9%, means that this has not been a strong of a year for the majority as many would think based solely on looking at the Dow. Indeed stock bulls can thank the Fed for uttering the word "taper" as the spark for the Great Rotation, but all that is doing is causing massive disconnects with prudent risk managers must pay attention to.

Discipline over time will win out over chasing extreme moves that are unlikely to repeat again. On that point, for a short-term trade our alternative ATAC models used for managing our mutual fund and separate accounts have rotated out of large-caps and into shorter-duration bonds. This likely will not be a prolonged trade, and the next major move remains likely to be emerging markets. If the Fed knew all along that the only way to create the wealth effect was by scaring market participants about a tapering of QE, they succeeded. The problem is that if the wealth effect does not translate into economic velocity, then the only thing getting tapered is faith in the Fed.

Only thing left to say? Enjoy Thanksgiving with your loved ones, and be sure that you are eating turkeys, not honey badgers.

Source: Bulls Give Thanks To A Single Word

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: 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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