Will the ‘Mini-Correction’ Turn Major?

by Michael A. Gayed | June 4, 2012 10:18 am

“Leadership is, among other things, the ability to inflict pain and get away with it — short-term pain for long-term gain.” — George Will

Followers of my writings are aware that I have been extraordinarily bullish on equities under the macro theme of 2012 being a year of reflation similar to 2003 and 2009, which I still believe will likely be the case.

However, as I noted here on InvestorPlace on April 16[1], the odds of a “mini-correction” had been growing as my company’s own ATAC (Accelerated Time And Capital) models used for managing client accounts sensed a deflation pulse.

Since then, worldwide markets have declined precipitously, particularly after the May 6 European elections, as fears of Greece leaving the euro, a shaky Spain and bank runs have sent “risk” assets tumbling as bonds around the world spiked up in price and collapsed in yield.

I have maintained all along that if the correction in the U.S. ended up being shallow, it would further the case for the “spring switch” out of bonds and into stocks to get flipped as a “great reallocation” would take place.

The iShares S&P 500 Index Fund (NYSE:IVV[2]) remains positive for the year as of this writing, something that many are likely shocked by since this correction feels much deeper than it has been for large-cap indexes. While conditions still favor being cautious, I do think we are nearing a crescendo in this period, where either the bond market will be proven right as a global financial collapse occurs (which is what current all-time panic low yields are signaling) or the stock market will surge as the “end of the world” trade ends up proving false.

In my April 16 article, I made the case that one of the reasons I believed the correction would be “mini” was the relative performance of European financials against the S&P 500.

Below is an updated chart of the iShares MSCI Europe Financials Index ETF (NASDAQ:EUFN[3]) relative to the IVV. As a reminder, a rising price ratio means the numerator/EUFN is outperforming (up more/down less) the denominator/IVV. A falling ratio means the opposite.
Click to Enlarge

On April 16, it looked as though the ratio was stabilizing around a support level. However, as talk grew of bank runs in Greece and Spain, the ratio has utterly collapsed, with the trend down remaining in place. It’s entirely possible that the speed of the decline could usher in a V-formation and recovery, which in turn would send equities higher, likely on a worldwide basis.

Because of this, I maintain my belief that while the correction is likely not over, it also is likely not going to be deeper than it already has been. After all, the bond market has already behaved as though a crash has occurred.

For investors wondering what to do, sometimes a wait-and-see approach is best.

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.

  1. I noted here on InvestorPlace on April 16: https://investorplace.com/2012/04/why-this-correction-may-be-short-lived/
  2. IVV: http://studio-5.financialcontent.com/investplace/quote?Symbol=IVV
  3. EUFN: http://studio-5.financialcontent.com/investplace/quote?Symbol=EUFN

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