Friday, November 9, 2012

Blame It On Obama?

Michael Gayed, chief investment strategist and co-portfolio manager at Pension Partners, writes, Obama NOT to blame for the correction:
The hard selloff in equities Wednesday seems to have taken many by surprise, with various pundits arguing that the drop was directly because of Obama winning the elections.

However, as followers of my writings know, deterioration has been in place within markets ever since QE3. Our ATAC models used for managing our mutual fund and separate accounts have been warning of a harsh environment for equities, keeping us in bonds despite every “nouveau bull” in the world believing stocks could not go down in the face of the "Bernanke Put."

The rhetoric over the decline is illogical given the behavior of price. As I stated on CNBC , if the decline were because of Obama, then 30-year yields would NOT have fallen as much as they have, the dollar would NOT be breaking out after bottoming nearly to the day of QE3 being announced, and Italy and Spain would NOT have performed as poorly in sympathy.

No, my friends, this is because of the bizarre way markets are acting following QE3, which was *supposed* to force reflation back into markets. The corrective risks I have highlighted since the end of September have persisted for longer than I thought they would, and the harsh environment for risk assets may not be over yet given the message of price.

Further proof of this may be the behavior going on in the commodities markets. Take a look below at the price ratio of the DB Commodities Tracking Index Fund relative to the S&P 500. As a reminder, a rising price ratio means the numerator/DBC is outperforming (up more/down less) the denominator/SPY. For a larger chart, visit here .

Remember how following QE1 and QE2, commodities rallied and performed better than stocks under the idea to buy on now for future inflation? The EXACT OPPOSITE has happened following QE3. In other words, commodities and the "supercycle" aren't looking too super, which again implies that the market is sensing the QE3 isn't going to force reflation.

Perhaps the market is under the assumption that unlimited isn't enough, and that the Fed may be countering itself through its open-ended buying. There is an argument to be made that by doing a mere $40 billion/month in a world where equity market cap is north of $55 trillion won't be enough.

There is also an argument to be made that the slow velocity of money, which has been a big problem for the economy, can only pick up if the crowd has a sense of urgency to use cheap debt. What's the rush if the Fed is willing to keep rates low for such a long period?

Whatever the reason is, price has been warning of a correction and deflation pulse for about six weeks now BEFORE the elections. So stop listening to talking heads, stop listening to pundits, and stop listening to spin. Instead, do yourself a favor, and listen to price.
Michael is a great strategist, one that I've tracked closely over the past year. You can follow him on Twitter @pensionpartners and YouTube by clicking here. The performance of the ATAC model speaks for itself, trouncing that of the overall market (not to mention that of most hedge funds).

Yesterday, Michael tweeted that we're heading back into bear paradox territory. There is little disputing the fact that so far, QEinfinity hasn't done much to reflate risk assets. In fact, the opposite is happening.

Moreover, all those gurus claiming that the titanic battle over deflation will sink bonds have thus far been on the wrong side of the trade. The rally in bonds should concern global central banks because it means they're losing the battle over deflation. Even pensions have given up hope, putting more money into bonds.

So is it game over? Is it time to declare deflation the winner, sell stocks and get into bonds to preserve capital? Not so fast. While I can't declare deflation is dead -- not by  a long shot -- I still maintain the biggest tail risk heading into 2013 is a huge melt-up, not a meltdown, in stocks. 

Why am I  so confident? Well, for one, I see the US recovery picking up steam over the next year. Hurricane Sandy will have a short-term impact on growth but once reconstruction starts and life gets back to normal for many people, you will see a pickup in employment growth.

More importantly, Sober Look posted results from a Merrill survey of US institutional money managers, showing which tail risks concerned them the most. Here are the survey results from September and October of this year (click on image to enlarge).

As you can see, the US fiscal cliff is the dominant concern in the financial community. Interestingly, municipal defaults rank at the bottom of the list, which is odd given that California bankruptcies could rock munis

Sober Look goes on to note the following on the US bond bubble:
Interestingly, the Merrill researchers who conducted the institutional investor survey (above), list "bond market bubble" as one of the key tail risks. And for those who still don't think we have a bond market bubble (and many investors don't), just take a look at the net fund flows in the last few years (bonds vs. equities; click on image to enlarge).

It doesn't mean that this bubble in bond markets can't persist for much longer. The US housing bubble lasted for years. Clearly the Fed continues to provide support to spread products for now, which makes the probability of a major spread widening quite low (thus a "tail risk").

When looking for "tail risks", it is therefore not helpful to zoom in on areas where the investment community and particularly the public is already heavily focused, such as the "fiscal cliff". The time for that was back in April and May (see post), possibly even earlier. Instead one should look at the less probable events that most investors are now simply ignoring.
Exactly, forget the US fiscal cliff (Neil Petroff at Ontario Teachers' told me the only cliff that scares him is "when skiing"), doomsday scenarios of a hard landing in China or a European collapse. Admittedly, Europe is a mess but that's hardly news. European leaders have bungled it up, pandering to insolvent banks while eurozone unemployment climbs to dangerous levels. But they are finally sobering up, realizing that mindless austerity is a one-way road to deflation and social chaos.

And even though Mitt Romney lost the election, I'm still bullish on US coal stocks, and think top funds are using the pullback to add to their positions in coal, financials, energy, and technology (by the way, the selloff in Apple is overdone, look for a nice bounce up).

All this to say that the correction has nothing to do with Obama. It's just business as usual for the wolves on Wall Street, always looking to scare the crap out of investors. Ignore the doomsday 'Obama forecasts' by the likes of Peter Schiff and Marc Faber. Almost as dumb as Bill O'Reilly's rant on the decline of the "white establishment." All this nonsense brought tears to the President's eyes (watch clips below).