“I learned more about the economy from one South Dakota dust storm that I did in all my years of college.” – Hubert H. Humphrey

About a month after the end of Quantitative Easing 1 in 2010, Treasuries began outperforming the stock market. By the time that leadership was over a few short months later, Treasuries outperformed the S&P 500 by 3000 basis points (30%). Defensive sector Utilities outperformed by 1200 basis points (12%). After the end of Quantitative Easing 2, a similar juncture occurred, resulting in Treasuries outperforming by 4000 basis points (40%) in an even faster period thanks to the Summer Crash of 2011. Utilities beat by 1500 basis points (15%).  We are now a little over a month in time following the end of QE3.  The Treasury/stock ratio has just begun to move.

Those who have invested in or are watching our inflation rotation alternative strategies may be shocked if such a situation is about to occur again. Recall that our inflation rotation model rotates to Treasuries based on our risk trigger. What goes into our risk trigger are proven leading indicators of stock market volatility. Should the post QE playbook work, an enormous spread could take place between Treasuries and stocks, which means massive strength in that strategy.

Alpha is not generated from being up more but mathematically from being down less. The vast majority of outperformance over time comes from missing large downdrafts in equities. It is precisely for this reason that the presentations I've been doing around the country focus on generating alpha through assessing conditions which favor stock corrections and volatility. In the small sample period of the last year and a half, there has been an abnormally long period of non volatility and smooth market behavior where every risk rotation to be defensive has either failed with hindsight as stocks moved higher, or the trigger worked as it did mid-January and early October, but only for two short weeks.