Did the recent “tech wreck” (the one that Goldman definitely didn’t cause) give you flashbacks of the dot-com bust?
For some traders/analysts out there, the answer to that question is invariably “no,” because it seems likely that a lot of the folks manning the desks on the Street these days were in high school when the tech bubble burst.
But let’s just assume that even if you were poppin’ Vicodin in first period and/or hiding pints of Jack under the front seat of your first car on prom night when the Nasdaq collapsed, you now know that it happened and that is was bad.
And because veterans that were trading at the time have told you how bad it was and have also suggested that the relentless rally in FAAMG is starting to look like a setup for a 2000 redux, you’re concerned about how you might hedge a tech collapse.
Furthermore, you’re really liking the argument for owning duration these days because, well, because look at long-term yields – they’ve got a one-way ticket lower thanks to lackluster econ data and a Fed that’s now tightening into a deflationary death spiral.
So naturally, you’re thinking that what you’ll do to hedge against any further FAAMG FUBAR-ed-ness is get long Treasurys because i) rates are going lower, and ii) you think the negative stock-bond return correlation will persist, giving you a natural hedge against an equity drawdown.
Well if that’s what you’re thinking, BofAML has the following message for you:
It is now well understood and socialized that the policy mistake trade in US rates is underway. As we expected, a dovish hike was nearly impossible to deliver and the Fed’s actions and tone were interpreted as being stubbornly hawkish in the face of weak data. Chart 1 shows the decomposition of the 5y rate move since February – The decline in rates we have seen is a unhealthy decline with real rates much higher and inflation expectations much lower. This validates our message from last week that real rates offered a better protected short than nominal rates (5y real up +18bp since last week). But it also justifies the crack we are seeing in growth /risk assets. Ultimately, growth assets are discounted by real rates which are now 50bp higher from pre-election levels.
This week we focus on two key messages: 1) Rates offer a bad hedge to a tech sell-off; 2) If we are indeed nearing the end of the cycle as forward Fed pricing would suggest, intermediate curves have more room to flatten.
FANG vs. rates
One of the strongest arguments used by duration longs at these levels has been protection against an equity market sell-off. History disagrees – at least comparing to the tech sell-off in 2000.
The tech bubble from Oct 99 – March 00 saw the Fed deliver two hikes and the belly of the curve lead the rate move higher.
But surprisingly the sharp sell-off in the NASDAQ from March 00- May 00 did not see yields move lower. In fact, this period saw 10y yields higher by 10bp while the 2y yield ended 30bp higher as the Fed continued to hike.
Although the move in long term yields was lesser than expected when considering that the Fed hiked three times in this period, the bigger surprise was the complete lack of diversification provided by Treasuries against a 35% decline in tech stocks.