International equities are being favored over US Equities. Further, the U.S. sector and industry strategies are defensive; favoring staples, health care, and consumer discretionary. Funds are flowing into bonds in general and emerging bonds are the strongest bond class. For the second month in a row the Euro is the strongest currency. An interesting spread in our Equity Income Index shows short US real-estate and long international real estate.
The underlying theme is an interesting "risk off" rotation. Normally, the "risk off" trade results in a higher dollar and lower exposure to equities. The "risk off" trade in the current "fiscal cliff" continues to show a flight not only to bonds, but also to markets outside of the U.S. (specifically foreign markets that trade in the Euro or the Swiss Franc) and to the Eurodollar (as opposed to the U.S. Dollar as we would expect). After further research, our understanding of this rotation was validated by the fact that the correlation between the Eurodollar and the US Equity markets is breaking down, at least in the short term. Generally, when the Eurodollar pair goes up, so does the US market and vice verse. Yesterday, as a perfect example, after the European markets closed at 11:00 am EST, the US markets fell as the Eurodollar pair continued to climb.
Why is all of this interesting? It is interesting, because the goal of our quant models is to follow the money. The models are not only picking up a "risk off" bias, but they are picking up an alternate trend in the course of "risk off" being:
Long equities that trade in the Euro
Long bonds and more specifically bonds that are not US dollar denominatedÂ
Short US real estate and long international real estate
In short, our model indexes are suggesting to be defensive and don't be in the US Dollar. Â It will be interesting to see how this plays out in the coming month of "fiscal cliff" negotiations.
About "PCM Quant Coalescence"
Welcome to Provident's bi monthly "Quant Coalescence" communication. We suspect that many of you are no different than us. That is to say that when our quantitative models rebalance every 2 weeks for some indexes or once a month for other indexes, you sometimes find yourselves asking "What is behind a rotation into that ETF?" This communication is our opportunity to "unite for a common end" with our clients and partners; keeping you updated on our thoughts and perspectives.Â
As you know, our indexes are based on an absolute approach: we strive to make money in up markets or down markets, while trying to greatly minimize loss in any market environment.
Our indexes are also quantitative, reflective of our systematic, unbiased and technical approach. Â Since our indexes are unbiased, the quantitative models would obviously at times rotate into positions that cause us to scratch our heads. Nevertheless, being so close to the analysis as it unfolds, allows us to quickly begin to validate the fundamental reasons behind the quantitative "following of the money." At other times, the trades are not validated right away; the story unfolds as the days pass.
We have been very excited about many of these "validations" and "ah ha" moments. We had another "ah ha" moment when we decided that these insights would also be interesting to those who have entrusted us with their financial peace of mind. Â Our goal is to be short and to the point, specific to what is happening in our indexes rather than a lengthy macroeconomic perspective.
We hope this has been helpful and informative!