“Stocks have reached a permanently high plateau.” – Irving Fisher, just before the 1929 Crash

Equities and Treasuries closed August having one of their best months of 2014 respectively, as bonds continue to price in global deflation at the same time equities completely ignore that possibility.  Global inflation has fallen to 56 month lows according to GaveKal research, which indicates that bonds have future growth and inflation expectations right.  To say that Treasuries are in a bubble or are yielding nothing lacks of a fundamental understanding of what real returns after inflation are.  If a bond yields 0.1% and inflation is -10%, that is a phenomenal rate of return.  Whoever thinks that low bond yields and falling rates are bullish have fallen prey to a narrative which Japan has disproven.

Put simply, bonds are correctly pricing in deflationary risks.  Stocks are not.  That is not open to debate.  That is fact.

Yet, of course the narrative of stock market movement always follows price, as the crowd deludes itself into trying to justify why equities should continue at this pace. People forget that interest rates are the heart, soul, and life of the free enterprise system, and that falling rates are reflective of the demand for money. That demand for money drives everything, and is the core fundamental difference between socialism and capitalism.  To completely forget the fact that bonds tend to be more right than stocks about the future, and to ignore the enormous disconnect between the two, is simply lunacy and completely disregards cause and effect.  Economic data continues to be marginally positive, but what happens when data actually begins to miss expectations?  What will bond yields do when data is actually worsening when they have been falling into better data points?

Being on the road, I am glad to see that other colleagues and professionals in my field are first and foremost focused on process and academic research.  Far too many investing in markets completely ignore large samples, award winning papers, historical results over multiple years of money management, and context.  There is an old adage that when performance is strong, you sell performance.  When performance is weak, you sell process.  No – process drives everything, long sample periods are all that matter, and context appreciation is the only way to understand results.  Those that continue to be mesmerized by buy and hold investing ignore the context of the boom in equities given factual deflationary pressure everywhere, and how fast declines can happen when you least expect it.

Stocks are not meant to be a deflation hedge.  Once again, this is not open to debate, and is fact.  Japan’s Nikkei average has had multiple 20+% moves before ultimately collapsing and repeating the cycle.  What matter is if process leads to repeatable results.  What matters is if wealth is created through big gains, or the avoidance of big losses.  What matters is a strategy, rather than an opinion.  This is not about calling for a top in stocks.  This is about calling for a top in strategy.  Buy and hold investors have been deluding themselves into thinking there is no risk, and that stocks have reached a permanently high plateau.  Yet, bonds are screaming and no one seems to care.  When the crowd does, it will likely be too late to manage risk.

We all live in but a small sample of time.  Many investors simply look at results, and say that a cherry picked sample in time – which disregards award winning research, knowledge, and time tested strategies -  means stocks have nowhere to go but up.  This is as delusional as thinking that doing a Google search on your physical symptoms gives you more knowledge and experience than a doctor who spends his or her whole life mastering the field of medicine.  If bonds are right, the self-diagnosis of chasing high beta cyclical stocks is going to have some nasty side effects.  For our alternative, absolute return uncorrelated inflation rotation strategies, when Treasuries diverge from equities, the resulting spread can be substantial.  For our equity sector beta rotation strategies, risk management means taking a long-only sector position in those sectors which tend to be less sensitive to equity volatility and economic weakness.

And that, Nouveaux Bulls and Gray Haired Bears, is the only bottom line that matters.