One of the themes I’ve talked a ton about over the past two weeks is the extent to which the anomalous (from the perspective of where we are in the hiking cycle) bear steepening episode that accompanied the October bond selloff helped catalyze an unwind in what’s generally worked for equities during the low-flation environment.
For all the focus this year on the steady grind flatter in the yield curve and what that might portend for the U.S. economy, it’s worth noting (and I’ve mentioned this before too), that it’s actually steepening which often opens the door to volatility, first in rates, and then in other assets. In February, for instance, the curve steepened in and around the equity rout.
If you think about the bond selloff as the market catching up to (or, becoming a believer in) U.S. economic strength, you can divine something about what the steepening is likely to entail from a sector/factor/style perspective.
As Nomura’s Charlie McElligott wrote earlier this month, the growth-inspired steepening episode “was the catalyst for the ‘Momentum’ factor unwind, which corresponds with a reversal in the Growth/Value ratio, as ‘Long Growth’/ ‘Short Value’ has been de facto positioning and the performance driver for the last two+ years.”
In other words, the selloff in the long end catalyzed by the bond market suddenly catching up to ebullient U.S. economic data is reflected in equities via a rotation out of what McElligott calls the “secular growth ‘hiding places'” such as FAANG and tech more generally. Those names, he reminds you, “were accumulated from the lazy multi-year ‘slow-flation’ U.S. economic narrative and are now being reduced.”
In the week since the initial October surge in yields, the “it’s about the bond market catching up to ebullient econ” narrative seems to have shifted a bit. But let’s not go down that rabbit hole right now, because you know, “brevity” is sometimes a virtue.
On Tuesday, McElligott is back with a short note and in it, he writes that “the MTD ‘Value / Growth’ rebalancing—as yield curves have bear-steepened—is now a GLOBAL phenomenon.” To support the “global” characterization, McElligott rolls out the following visuals:
“Whilst strong factor moves often lead to accusations that ‘it was the quants’, it is clear to us that many were underweight Value stocks and equally exposed to higher bond risk via expensive Growth stocks”, SocGen’s Andrew Lapthorne wrote on Monday, adding that “a strong reversal was always a risk.” The following chart accompanies Andrew’s latest piece:
Who knows, maybe Netflix can turn the tide when it reports after the bell on Tuesday.
Another disappointment there could conceivably catalyze another leg lower for Momentum at a rather delicate time.