The much awaited correction in risky assets has finally come and volatilities are on the rise globally.  A perception that the FED is preparing the ground for a normalization of monetary policy is forcing a compression of leverage across the board.

This dynamic explains the rise in correlations and a somewhat abnormal increase in volatility especially in Emerging Markets.  Chairman Bernanke indicated yesterday that, while still being data dependent, it is reasonable to expect a reduction in asset purchases by the end of the year and a possible conclusion of the program by mid-2014 when the unemployment rate is predicted to drop to 7%.  No hint was given to inflation levels and how they may delay the plan should the risk of deflation remain high.  Bernanke also indicated that the FED will not sell any of its agency paper, an announcement that does not surprise us as that trade really had no exit from the start.

Markets do not usually wait for actual deadlines to arrive and being discounting mechanisms they produced an acceleration of the higher yields trend that started a few weeks ago.

From an investor’s perspective, one needs to analyze the contingencies in order to decide on tactical or strategic moves.  The telegraphed change in monetary policy is being presented as the result of much improved economic fundamentals; in this case, an investor should expect cyclical assets to do well in the longer term (the strategic view) while being volatile in the short term as leverage compresses (the tactical view).  We tend to agree with this assessment and believe that real and income producing assets should be looked favorably as valuations become more appealing in a correction.  On the other hand, almost all fixed income should disappoint even though we think the process of normalization of monetary policy will be a long one.

The following are some statistics on the correction in most asset classes from the recent May top to today:

US Equities (S&P 500):                                 - 5.87%

MLPs (Alerian Index):                                    - 7.43%

US REITs (Vanguard VNQ):                           - 16.66%

Global REITs (Vanguard VNQI):                     - 17.94%

Emerging Markets Equities (EEM):               - 16.69%

US 20 year Treasuries (TLT):                        - 11.07%

VIX:                                                                 + 64.58%