“For the loser now, will be later to win, for the times they are a-changin’” – Bob Dylan
The losers in 2013 were the asset allocators, the risk managers, and basically anyone who exercised any sort of prudence when it comes to trading or investing. The winners, of course, were those who bought U.S. equities on margin, ignoring any and all bearish signals. Well, as Bob Dylan said, the times they are a-changin’.
In my past few writings, I have discussed the return of risk management in 2014, increasing risk signals, and signs of weakness in the U.S. consumer. The common theme in these writings was to avoid complacency following an abnormal 2013 and start paying closer attention to risk-off behavior. At the end of last week, our ATAC models used for managing a mutual fund and separate accounts moved us into long-duration Treasury bonds, expressing a more defensive outlook for the time being.
In confirmation of this view, we have seen continued signs of a potential deflation pulse this week, with bond yields dropping precipitously, defensive sectors such as Utilities (XLU) gaining relative strength, and industrial metals such as Copper (JJC) underperforming precious metals such as Gold (GLD). Until yesterday, the one holdout had been U.S. credit which remained strong.
That all changed last week, with credit spreads in the U.S. finally widening. The chart below illustrates the ratio of High Yield Bonds (HYG) to Treasuries (TENZ). As you can see, it is starting to turn down, an indication of credit weakness. This is the first sign of weakness in this ratio since last September when the S&P 500 (SPY) saw a correction of close to 5%.
The move lower in U.S. credit is confirming the more troubling move down in Emerging Market credit. The chart below illustrates Emerging Market credit spreads, which saw a significant widening in trading that brought spreads back to levels last seen in mid-December.
Overall, as long as these signals remain weak, continued caution is warranted. As I wrote in prior writing, risk management is only effective as an ex ante process. By the time the correction occurs, it is often too late to protect capital. Given the strong uptrend for U.S. equities that remains in place, those simply following the trend here are unlikely to get out before significant damage is done.
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.
