November, 2014: Fed follows through with end to Quantitative Easing
Equity indexes experienced a rollercoaster ride in October. The major equity indexes experienced a long awaited and close to 10 percent sell off, only to experience a "v shaped" recovery of all of the losses within another 12 trading days. This "v shaped" market recovery, the most dramatic in such a short time period since 1901, was fueled by St. Louis Fed's President James Bullard's comments on October 16th that the Federal Reserve should consider delaying the ending of Quantitative Easing. This sent the markets a signal that the Fed is planning to jump right back in at the first sign of any (very normal) volatility. He has since walked those comments back and for now it appears that the Fed's stance is that stimulus is no longer needed and that rates should begin to increase next year. At the worst of the mid October sell off, with the S&P down over 7% month to date, most PCM Indexes were in positive territory, with only a few down albeit very slightly. At the mid-month October reallocation, PCM indexes remained conservative, yet did not enter inverse positions, which is fortunate in that avoided being "whipsawed". Further gains were seen in the market late last week when the Bank of Japan announced a new and aggressive quantitative easing program, just as the U.S. is winding ours down. For the November reallocation, PCM Absolute U.S. Sectors went into consumer staples, utilities and remained in healthcare, the latter being an especially strong performer for the index last month. PCM U.S. Industries is now in REIT's, consumer staples, utilities and food and beverage, as both indexes went into more conservative equity positions. With quantitative easing in the U.S. ending and higher rates on the horizon vs the Bank of Japan starting the printing presses and the equity markets entering into a seasonally strong period, it will be interesting to see if it's the bulls or the bears that bring in 2015.
The November reallocation of the Emerging Market Equity Index sees it spread off with exposure to inverse emerging markets, while being long India and emerging Asia Pacific. The announcement by the Bank of Japan mentioned above should push the dollar to continue its strength against the yen. There are many macro-economic outcomes that could result from dollar strength against the yen. The U.S. equity markets movement up or down is historically highly correlated to the dollar/yen currency pair. As this pair goes up in price, the U.S. equity markets should as well, although this correlation can break down at any time. When it does, that generally signals a reversal, after which the correlation will pick up again. If you want to watch this correlation in real time, watch the yen being quoted when you turn on CNBC. Although it will show the yen up or down, the CNBC quote is actually referring to the dollar yen pair. When it shows yen being up, it is actually the dollar that is up against the yen. For our purposes, if the quote on CNBC shows yen up, the markets should generally be up as well and vice versa. If not, the correlation is "breaking down" and that could be signaling a change in direction for the market. The reason I share this is that it explains why the markets reacted so positively when the Bank of Japan said they will be printing money and therefore making their currency weaker against the dollar.
The strengthening dollar is also a reason for the weakness in oil and gold that we have seen recently. As the dollar gets stronger, it takes less dollars to buy these commodities in the world market, where the dollar is the reserve currency and everything is priced based on the strength or weakness of the dollar. PCM Total Return and Stable Growth Plus have both been in line with these trends, as they have had recent long positions in the U.S. dollar and are currently inverse a position in gold. They both also have a heavy exposure to the conservative equity sectors mentioned above. (Please note that performance numbers on the website for indexes do not include dividends and are appropriately calculated sequentially.)
The PCM Global Tactical Index is also inverse gold, as well as long U S. dividend paying stocks, emerging market bonds, consumer staples, and utilities. The Alpha One Index is in dividend paying U.S. equities. PCM Absolute Metals Index is invested 50% aluminum, with the remaining 50% allocation in cash equivalent, while PCM Commodities Index is long cotton and cash equivalent.
The PCM US Bond Index is allocated amongst varying maturities in U. S. Treasuries and U.S. corporates, while the PCM Absolute Bond Index is in emerging market bonds and 20 year U.S. Treasuries.
By: Melissa Wieder, CFP®, Director Institutional Services
Collaborative insight provided by CIO Michael Chapman
The views and strategies described herein are for illustrative purposes only and may not be suitable for all investors. The information is not based on any particularized financial situation, or need, and is not intended to be, and should not be construed as investment advice or a recommendation for any specific PCM or other strategy, product or service. Investors should consult their financial advisor prior to making an investment decision. There is no guarantee that these investment strategies will work under all market conditions and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. This material contains the current opinions of the author(s) but not necessarily those of PCM and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission. Provident Capital Management, Inc, PCM and Absolute Return Index are trademarks or registered trademarks of Provident Capital Management, Inc., in the United States.©2013, PCM.
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. 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. 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. Our goal is to be short and to the point, specific to what is happening in our indexes rather than a lengthy macroeconomic perspective.