Mr. Value, Meet Mr. Momentum
As we mark the one year anniversary of Covid, cross asset markets are full of cross currents, some well worth musing on.
While it may not seem like it, the equity volatility indicator (VIX) dropped below 20 this week for the 1st time in over a year, suggesting a possible exit from the high volatility fears of the Covid Age (note realized vol has been much lower - JPM’s “Fear” market).
This syncs up with BofA’s manager survey noting that Covid is no longer risk #1, having been supplanted by inflation and taper tantrum fears. The bank also reported that none of these concerns have slowed the flow into equities, noting that current record inflows, if annualized, would equal $1.6T, a 5 fold increase over 2017’s record.
One wouldn't know it from the “risk free” asset, the UST market where the long end (TLT) has entered a bear market (forecast here some 4 months ago). A combo of record bond dealer selling ahead of the SLR decision, technical issues & inflation fears has led to a rapid repricing and a Yield Curve steeper than during the 2013 Taper Tantrum. Alpine Macro notes 1.7% 10 yr as pushing past Fair Value.
Jay Powell has been very clear - the Fed is now data dependent which is something we should celebrate - data targets can now act as stabilizers - something one also wishes for fiscal policy. In the monetary policy realm it should provide clarity if not immediately then in the short and medium term. In terms of inflation risk, one wonders about the velocity of money which looks like something the cat dragged in… dead as a doornail. A transitory, mechanical inflation pick up is baked in, sustained, worrisome inflation is a longer stretch though some inflation models are starting to heat up.
Higher rates are good, they get us off the zero bound over time, imply a more robust economic activity level, reinforce the Great Rotation & support the Covid inspired paradigm shift amongst the various thematics.There can be too much of a good thing however and BofA’s survey notes that managers see a 2% 10 yr as = to a 10% equity correction.
How fast we get there is my main concern - if straight line then equity will find it tough to advance - even a market with as good a breadth profile as this one. Yields have risen sharply in a very short time, will demand pick up to meet supply?
Over in Commodity land it's worth noting that the “pothole” market syndrome hit the oil patch this week, with oil's biggest one day fall in 6 months capping a 5 day losing streak that has taken almost 10% off the WTI price and impacted the equity space. Some of this should be expected, after all, XLE was up 40% YTD. What's interesting is that the 10 yr yield had been rising in sync with rising oil prices as noted a week ago. This relationship seems to have broken suggesting new worries, perhaps supply related, creeping into the bond market.
This all ties together & manifests in the traditional 60-40, risk parity, balanced fund space where durations are at the 2nd highest level in 50 years given long duration tech stocks’ equity weighting. This space has absorbed huge flows in the past decade, benefitting from the twin engine bull markets in stocks & bonds - that game is over - where the $ goes next is worth pondering.
As all this unfolds, Mr. Value is about to meet up with Mr. Momentum, as the latter seeks a new relationship after having hung out with Mr. Growth for nearly a decade. Next week marks the one year anniversary of the Value- Growth low, suggesting the quant space could help provide the next up leg for Value. JPM notes Momo’s migration to value as the cycle accelerates and economies move to reopening. This Factor mashup could be key to equity performance in the coming quarters.
I also note that Marty Pring, one of the most respected market technicians, is saying that long term equity leadership is in the process of moving away from technology towards energy & other resources. When multiple market disciplines line up together - that's usually a signal to invest in size. Here we have the Tech Kryptonite argument in the fundamental space, Marty’s technical argument & the JPM Quant argument - all saying the same thing. This is one to watch; an awful lot of money has been invested in Growth/Momentum over the past decade.
It all starts with Health and while the US vaccination process continues to accelerate, the same can't be said for Europe where it has been one mess up after another - giving even an EU bull like me agita. Now that the AstraZeneca vaccine has been reaffirmed as safe to use, one hopes for a successful EU vaccine reboot as countries go back into lockdown to offset more aggressive variants.
The divergences between US and EU vaccination efforts, current growth profiles and within the EU, between Manufacturing and Service PMIs suggest we are near the wides in all three cases. A narrowing of these divergences should be positive for EU assets including the Euro as US exceptionalism favors the USD while global reflation is USD bearish.
Geographically, both Alpine Macro & JPM highlight Europe as a store of value - especially the banks selling at .6 forward PE relative to the broad market while the DAX, hitting new ATHs, sells at 15x forward E vs roughly 20 for Dev markets.
On the Crypto front it was interesting to see the old Firm, Morgan Stanley, announce that its wealthy clients could invest up to 2.5% of net worth in Crypto - taking JPM’s 1% suggested allocation and raising it quite a bit. BNY-Mellon, the world largest custodian, also made news buying a Crypto firm as it gears up to take custody of such assets.
A quick aside on the US - China talks - my take is that the messages coming out of China’s Two Sessions meetings are more important, namely less robust climate action as energy security trumps climate concerns, a continued focus on reigning in Big Tech - “Big Tech prospers at the Party’s pleasure” and the first inklings of a liquidity pullback, already visible in an equity correction. 1st in, 1st out?