“Leadership is, among other things, the ability to inflict pain and get away with it — short-term pain for long-term gain.” – George Will
Markets have been notably more volatile over the past two weeks given a slew of macro news that has woken the bears from their slumber following the best first quarter in many years for risk assets.
The initial wave of selling was sparked by the release of Fed minutes two weeks ago that suggested the Fed was not in favor of initiating Quantitative Easing 3.
Only days after, investors began making bets once again that the Fed would initiate further stimulus as jobs data in the U.S. came in soft. Investors then turned their attention overseas. The Bank of Japan kept policy unchanged, deciding not to expand its asset-purchase program, while China’s growth rate declined more than expected.
The biggest worry, though, remains Europe — particularly Spain, as its 10-year yield neared the panic level of 6%. Concerns relate to Spain’s economy and its government, which seems unable to control spending and debt, which in turn is greatly increasing the odds of another eurozone bailout. Data show that Spanish banks borrowed a significant amount from the European Central Bank in the past month, signaling deep financial stress. This has largely pushed investors in risk-off mode as Treasury yields fall in response to the flight-to-safety trade.
I remain bullish on equities, which I believe are in the midst of a 2003/2009-like environment. However, as I noted to followers of my company’s Twitter handle (@pensionpartners), our ATAC models sensed a deflation pulse and positioned us largely into risk-off mode. I do think we’re likely in a mini-correction here.
What makes me say “mini?” Take a look below at the price ratio of the iShares MSCI Europe Financial Sector ETF (NASDAQ:EUFN) relative to the S&P 500 (NYSE:IVV). As a reminder, a rising price ratio means the numerator/EUFN is outperforming (up more/down less) the denominator/IVV.
Click to EnlargeEuropean Financials strongly outperformed in January following the significant period of weakness the group suffered through in 2011. I noted in prior writings that the strength of European Financials was a very bullish sign for markets. Following January, though, the ratio flat-lined and began lagging starting in mid-March.