“Finally I’m becoming stupider no more.” – Paul Erdos

This is perhaps one of the most exciting periods in recent history for the stock market.

Since the Federal Reserve embarked on Quantitative Easing 3, we have been living in an anomaly. The stock market made remarkable gains, led by all the wrong stuff. Because of central bank suppression of interest rates, those parts of the marketplace which tended to be most defensive (Utilities, Staples, Healthcare, and Treasuries) ended up being the best way to play offense. There is a direct link between yielding investments, volatility, and animal spirits. Quite simply, if you’re excited for the stock market, you historically wouldn’t play that by being in the most boring parts of the marketplace. Instead, you would favor cyclical sectors, and emerging markets. This whole concept got flipped on its head in the last market cycle.

For anyone that has relied on historical relationships, this has been frustrating and wildly underappreciated by both the media and the average investor. In each of our award winning papers, we show that historically, those defense plays (notably Utilities and Treasuries) have tended to be leading indicators of volatility (click here to download the papers). Those defense plays ended up not being leading indicators of volatility, but leaders in a no volatility world. That low volatility environment was very favorable for beta and specifically mega-caps.

It is clear now that things are changing and maybe, just maybe, we are on the verge of true normalization in market behavior where up capture is driven by cyclicals and emerging markets. It is ironic that many of the best performers in an election year actually end up being outside of our walls. Financials are starting to lead, as Utilities begin to break down. All it took was one of the most historic six week drops in the VIX ever to finally create a flip in market leadership.

Visibly, anyone paying attention to market behavior sees this. Whereas emerging markets, when they opened the morning session weak would continue to be weak in the past, now buyers are stepping in causing many broad based overseas ETFs to outperform by end of day. On strong dollar days driven by improving economic data and expectations of Fed hikes, cyclicals power through. Risk-on is looking more and more risk-on. Risk-off then becomes exceedingly risky for asset allocators who have tilted their portfolios towards yield. Bonds and dividend plays from a buy and hold perspective may be in a world of hurt if this trend continues.

Finally, historical relationships are making a comeback. And for anyone relying on them, that means the future path of their strategies looks ever more exciting.

*Beta Rotation Index, +9.57% Year to Date thru 8/5/2016, remains in offense mode (click here for why this matters)

*Pension Partners Tactical Exposure Model +12.58% Year to Date thru 8/5/2016