By Michael A. Gayed
Amazing how all it took was seven trading days at the start of 2016 for everyone to scream that a bear market began, and how quickly that conviction faded now that the S&P 500 /zigman2/quotes/209901640/composite SPY -1.96% is down about 2.5%.
This has been a bear market that has lasted for some time. Behaviorally, Treasurys /zigman2/quotes/206026314/composite TLT +1.19% and utilities /zigman2/quotes/206645117/composite XLU -0.19% largely led the way higher. Behaviorally, these are the exact areas of the marketplace that tend to outperform in bear markets. Small-caps and emerging markets /zigman2/quotes/201454250/composite EEM -1.45% have been remarkable weak in the past cycle. Commodities? Don't get me started. Unequivocally, if you didn’t look at mega-cap stocks, you would likely state that things have been bad for a long time now.
"Every new beginning comes from some other beginning's end."
We don't know whether a bear market is over or not except with the benefit of hindsight. All we can do is manage the here and now. Some will use moving averages to do that. In our brand-new 2016 Dow Award-winning paper, "Leverage for the Long Run" (click here to download), we myth-bust the idea that moving averages tell you anything about whether you're in a downtrend or uptrend, and as such, whether you're in a bull market or bear market. Moving averages, quite simply, tell you about probabilities that favor higher or lower volatility regimes. They are not trend indicators. They are risk indicators.
So that doesn't necessarily help with arguing we are at the start of a bull or bear market. What might? Inflation expectations. For the most part, bear markets coincide with faltering inflation expectations, while bull markets are characterized by reflation. As much as I am broadly a believer in the global deflationary structural thesis, the drop in inflation expectations may be on the verge of reversing and actually mark the start of the reflationary melt-up.
Take a look below at the price ratio of the iShares Barclays TIPS Bond Fund ETF /zigman2/quotes/200600110/composite TIP +0.62% relative to the iShares Barclays 7-10 Year Treasury Bond Fund ETF /zigman2/quotes/202862654/composite IEF +0.58% . As a reminder, a rising price ratio means the numerator/TIP is outperforming (up more/down less) the denominator/IEF. A falling ratio means the opposite. A rising ratio means inflation expectations are rising. A falling ratio means it's not.
It's been a long bear market in time. There is hope that inflation expectations do rise here and undo the downtrend. That would not be characteristic of a "new" bear market, but actually a bull market in everything which is most sensitive to reflation (commodities, high-beta, emerging markets). With the degree of conviction bonds are expressing through negative yields globally, one must ask if all of that extreme conviction is actually wrong about what the future holds.
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