The year is still young and there are already some interesting divergences between assets with high historical correlation. The textbook definition of an uptrend is a low correlation market aka market of stocks. I don’t want to make any striking conclusions based on a few days of data, but here is what I am seeing so far:
1. U.S. Financial stocks have their issues, but in 2012 they are like a breath of fresh air compared to their European counterparts. The number of regional U.S. bank stocks ($KRE) near 52week high continues to expand, while in Europe the most popular bank has become the mattress ($EUFN). Maybe this is why all home furnishing stocks are doing so well at the start of the year ($SCSS, $TPX, $LZB, $PIR..)
2. U.S. equities and the Euro Index ($FXE) are parting ways for the first time in years. Over the past 6-7 years, there has been very strong correlation between the two, backed by trillions of dollars of carry trade money. The divergence here is certainly a major change of character that will impact the capital allocation of a lot of macro managers.
3. The U.S. Dollar Index ($UUP) and gold ($GLD) are rising together. This has happened before, but not for an extended period. No major conclusions to make here. Just a temporary blip that will be arbitraged over time.
And finally for dessert, $SPY and the Shanghai Composite have separated paths once again. In the past, $SPY has been the index to follow Shanghai. Only time will tell if the situation today will be any different. As the saying goes, divergences could continues longer than you could remain solvent.
The month of January traditionally tends to give way to some unlikely winners: small caps, low priced and/or striking underperformers from the past 12 months. These types of stocks were sold in the later part of the year for either tax loss or reputational purposes. No fund manager wants to report to his/her clients that they own the year’s most striking losers or small caps with questionable business practices. As a result there is some forced selling in the 4th quarter and buying back in the first weeks of the new year.
For example, the first two trading days of 2012 were especially beneficial for some Argentinian bank stocks that were beaten down in 2011:
Weight loss stocks are also having a comeback. Not surprisingly, after taking into account many people’s New Year’s resolution to get in shape and the fact that $MCD went up 30% in 2011. A lot of calories have to be burned 🙂
Some of the declining stocks reverse course near the end of the year as the selling for income tax purposes subsides. Typical recent example is $OPEN.
This is something that happens consistently every year. A good setup to keep in mind.
The first investment theme of 2012 might be already taking shape and it looks like it is the good, old reflation trade. I have noticed the relative strength in numerous energy names over the past two weeks. According to Joe Kunkle, today this action is confirmed in the options pits:
: 1st Trading Day 2012 and Theme Developing in Options Action is Long Commodity, Short those impacted by input costs (apparel, restaurants) $$ Jan. 3 at 2:19 PM
Crude oil is threatening to break out to new 6 month high, while the beaten up in 2011 cotton and sugar are showing some signs of life. Gold miners continue to recover.
Meanwhile, we witnessed major reversal in inflation sensitive names in the restaurant industry: $BWLD, $MCD, $PNRA, $DPZ. One day does not make a trend, but it is certainly an interesting development to keep an eye on.
The reflation trade has been on and off consistently in each of the past 10 years. 2011 also had a period between February and April, when apparel and restaurant stocks suffered. The expectations for lower margins due to increasing input costs were short-lived and those stocks outperformed in the deflation labeled second part of the year.
The market tend to change its mind often and quickly, but occasionally there are periods of a few weeks to a few months, when it could stick to one theme and often over-discount it. Let’s see if reflation is among the first investment themes to take shape in 2012.