Chasing the reflationary Melt-Up
|June 18th, 2012, 06:08 PM||#1 (permalink)|
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Chasing the reflationary Melt-Up
"I could not understand how it could move under its own power. And when it had driven past me, without even thinking why, I found myself chasing it down the road, as hard as I could run." - Soichiro Honda
I have continued to stress in my writings over the last two weeks that markets are likely to "melt-up" as investors re-price out the "end of the world trade" and re-price in reflation (June 4th: Why another stock Melt-Up is likely ). The negative narrative I have continued to bring up has been extraordinarily powerful, with many using the story of 2008 as the mental anchor for how the eurozone crisis will play out.
Studies show that 1) people latch on to negativity more emotionally than optimism, and 2) that when presented with facts in a story format, the mind (mainly because of pattern recognition) overestimates the odds of something playing out the way the story is told. With much of the near-term uncertainty over Greece now over postelection, and the escalation of commitment by eurozone leaders to make sure Spain has enough capital, the bear trade unwind looks ever more likely.
Our ATAC (Accelerated Time And Capital) models used for managing client accounts sensed this, and flipped the switch going fully into equities at the end of last week. ATAC positioned our clients largely in bonds as the deflation pulse beat again in April, which was around the time I began making the case for a "mini-correction" which, due to the "bear paradox," would be shallow given rising dividend yields in the face of bonds yielding far less than the Fed's stated inflation target. Given how one-sided the trade of fear got through sentiment, bond market performance, and defensive sector strength, I am quite excited over the near-term. I maintain my belief that 2012 likely plays out like 2003 and 2009, with much more room for stocks to rally than the crowd thinks is possible.
I suspect there will be a lot of performance chasing now. The euro FXE -0.66% , for example, may undergo the "mother of all short-squeezes" as I addressed in a writing of mine on another site last week. The U.S. dollar UUP +0.44% in the short-term could get punished, particularly given the record number of long bets that occurred on a further rise of the greenback. I also think that the global growth story could soon replace the negative narrative as investors realize that the "Spring Switch" out of bonds and into stocks may have gotten flipped after all.
One area of the market I think most prone to a big rally ahead may be in Copper, since commodity prices are most sensitive to the return of global growth expectations, a falling U.S. dollar, and reflation. Take a look below at the price ratio of the Global X Copper Miners ETF COPX +1.42% . As a reminder, a rising price ratio means the numerator/COPX is outperforming (up more/down less) the denominator/Standar & Poor’s 500, as measured by the iShares Trust S&P 500 Index Fund IVV +0.23% in the chart below. For a larger chart, visit http://pensionpartners.com/marketwatch/copxivv061712large.PNG .
Copper has been a difficult place to invest in, dramatically underperforming since the ratio peaks of early 2011 and collapsing during the Summer Crash. The most recent breakdown was quite severe this year, as Copper Miners peaked out in February 2012 relative to the stronger S&P 500.
However, notice the area I have circled in the chart. The ratio appears to be building a bit of a base, and I suspect a period of leadership may soon return. Given recent policy action in China by the PBoC, and an easing of fears of an impending eurozone Lehman moment, it seems entirely plausible to think that Copper Miners could quickly absorb capital looking to invest in beaten down areas on a recovery trade. And while this is not just something I expect to happen to Copper alone, it seems like a plausible way of playing global growth expectations returning back to investor psychology, and as a way of playing China FXI +0.32% rate cuts given how much of a driver the country is of industrial commodity demand.
I suspect this next phase of the run higher will be driven by emerging market sensitive areas, as the rest of the world begins to catch up to the strength of U.S. markets. Looks to me like the chase is on...
Chasing the reflationary Melt-Up - MarketWatch