“Change is the law of life. And those who look only to the past or present are certain to miss the future.” – John F. Kennedy
Worldwide stocks rallied while bond yields rose last week as skepticism continued to plague traders over what happens next to risk assets. For the first time in a long time, the rally looked justified. Several risk-on relationships took hold, most notably in the sell-off of safe-haven trades. Gold, Treasuries, and Utilities, which had been on a tear in recent months, underperformed higher beta/more cyclical parts of the marketplace. The fact that this is happening in the here and now following the biggest 3-week decline in the VIX Index in history suggests that a real rotation may be occurring beneath the surface out of yield, and into more growth/capital appreciation plays.
Exhibit 1: VIX Index
Following Friday’s close, stocks after-hours dropped on news of a potential coup in Turkey. As of writing, it appears that this coup attempt has failed. It is unclear if this will impact the underlying rotation into cyclicals, but the fact that Erdogan has maintained power might be just enough of a reason for investors to ignore the reminder that political risk remains globally. Overbought can certainly remain overbought should the cyclical rotation continue.
Exhibit 2: S&P 500 Stocks Above 50 Day Moving Average
For another pulse higher in stocks to happen, a leadership change likely needs to occur not just in terms of moving away from yield and into cyclical sectors, but also in terms of country momentum. Emerging Markets have as a broad category been a difficult buy and hold investment, but have had several large tradeable opportunities. I believe that a secular shift in Emerging Market outperformance may be about to take place long-term. In the short-term, it is hard not to get excited about this. Emerging Market credit has been incredibly strong throughout the year as high yield credit spreads hit 13-month lows. At some point, the melt-up case asserts itself because of this.
Exhibit 3: Emerging Market High Yield Credit Spreads
We may be on the verge of a juncture where everything at once confirms another wave higher in risk-taking is about to take place. Key to this will likely be the behavior of Financials. Relative momentum is increasingly encouraging here, confirming that the yield curve’s fever may finally be about to break.
Exhibit 4: Regional Banks Relative to Market and Yield Curve
Bottom line? Conditions suggest a continuation of risk-on conditions in the near-term, and a potential secular shift away from domestic equities to international. There was a time when Emerging Markets pulled away from US markets and were the only play to be for many years. There was a time when reflation was believed and the bond market actually sold off.
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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