“Two roads diverged in a wood and I – I took the one less traveled by, and that has made all the difference.” – Robert Frost
Whenever I see headlines that read “stocks hit new highs,” I tend to cringe. Stocks are not hitting new highs. A particular index, the S&P 500, is. The German DAX has not for some time. The French CAC has not. Brazil has not. China has not. US small-caps have not. Yet, in a world where people are more interested in the headline rather than the content, it certainly feels like an incredible bull market in stocks. Sentiment surveys prove this given extreme optimism, when the reality is that most stock markets globally beyond US large-caps simply have not participated this year.
Friday, the “stock market” surged as investors cheered Draghi saying the same thing regarding doing whatever it takes to spur Eurozone inflation. The market rallies on words and not actions, and seems to forget that even if the ECB did Quantitative Easing, no round of QE caused inflation in the US, nor in Japan. The utter insanity of the current environment is the belief that 1) central banks are omnipotent, and 2) that they can cause inflation with bond buying despite screaming historical evidence that says otherwise. Manipulating markets in the name of the wealth effect only creates wealth inflation in the top 1% who hold assets, and not for the rest of the population which relies on income.
Having said all that, I think it’s important to address something which is underappreciated when it comes to the business of portfolio management. Too many focus on market levels and targets, rather than the path to those levels and targets. One of the hallmarks of the QE3 environment has been intermarket behavior which diverged substantially from historical relationships. This is well documented as it relates to the relationship of stocks to bonds to inflation expectations to commodities and to currencies. Any kind of a risk trigger has not mattered for US large-caps, and correlations have veered far away from average levels history suggests are reliable.
