The Markets May Be Starting To Worry About Rates

Equally problematic is when the stock market suddenly realizes that higher rates have derailed a primary thesis of overpaying for value.

Risk Appetite Is Extreme

It seems as if with each passing week, we have continued to point out levels of exuberance either rarely or never, seen historically. This past week continues to see increasing levels of exuberance on many fronts.

One that I will discuss more in Monday’s blog is the fact that no one is bearish.” Of course, that may be reason enough to be concerned.

As Bob Farrell once noted:

“When all experts agree, something else tends to happen.”

We must consider two issues.

The first is that current levels of speculation have increased the risk of a more extreme reversion. As physics’ fundamental laws suggest, a rubber-band stretched to its limit will experience a move of equal intensity in the opposite direction.

The second problem is the demise of the T.I.N.A. (There Is No Alternative) trade.

“The problem today is that the relationship between the 10 year US note yield and the S&P dividend yield has reversed. With risk-free rates of return rising, the 10 year US note now does provide an alternative – especially with the S&P dividend yield plummeting.” – Doug Kass

When “risk” becomes realized, there is now a “safe” alternative.

The shift will likely not be subtle.

Portfolio Update

From a portfolio management perspective, we have started to raise cash and reduce our equity risk somewhat. Our bond portfolio now has a very short duration, and high cash levels are acting as an early hedge against volatility.

We are not getting overly aggressive on hedging risk just yet as the money flow indicators, as shown above, remain supportive. However, that signal is beginning to get more extended, and the market is starting to show early signs of deterioration.

As I stated in the open, sometimes we need to act in advance of the correction. Such is particularly the case when there is excess speculation that can lead to very sharp single-day declines that make it extremely difficult to take appropriate actions amid a “panic-driven” sell-off.

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