Correction Risks Rise

"Prophesy is a good line of business, but it is full of risks." - Mark Twain

Hope over a deal in Washington, combined with expectations of a dovish Fed led by Janet Yellen, have put a bid back into stocks which had been hovering around some key technical levels in the US. Emerging markets continue to power higher, and the meme remains that "every dip is bought." This is of course true until it isn't and mentality breaks. Reflation remains the underlying hope for all bulls, even though it simply has not existed in 2013 based on how intermarket trends have behaved. That does not mean that inflation expectations can't rise from here, but rather that there is still much skepticism given that this is the first time QE has failed to juice fear over rising prices in the economy and a true pickup of economic growth.

Despite big swings up and down, money may finally be starting to pay attention. There has been notable improvement in defensive sectors which seem to be on the verge of reversing their divestment relative behavior. Take a look below at the price ratio of the SPDR S&P Dividend Index ETF (SDY) relative to the S&P 500 (SPY). As a reminder, a rising price ratio means the numerator/SDY is outperforming (up more/down less) the denominator/SPY.

(click to enlarge)

With the exception of the first half of this year, outperforming dividend stocks (a rising ratio) tend to be indicative of defensive positioning, which usually precedes a pickup in volatility and falling stocks in a deflation pulse environment. Note the far right where strength is gradually kicking in. Does this necessarily mean that money is starting to position for a corrective environment? Maybe, maybe not. After all, the last time this happened earlier in the year markets on an absolute basis did power higher. However, I do think some historical relationships may be re-syncing, ! meaning this time may be different than earlier in the year. Our own ATAC models used for managing our mutual fund and separate accounts are nearing a defensive rotation again given internal beta deterioration despite emerging market alpha momentum.

The greatest hat trick the market could pull now is if it does correct even with a deal...

Source: Correction Risks Rise

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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