“Stretched valuations and over-crowdedness are among the explanations for the moves”, Goldman’s Alex Meintel and Deep Mehta write, in a note explaining the epic factor rotations and unwinds playing out below the market surface this week.
Monday’s historic Momentum “massacre” was documented in real-time by Nomura’s Charlie McElligott, who followed up on Tuesday with an expansive postmortem, complete with a veritable smorgasbord of his signature annotated visuals. We summarized that instant McElligott classic here.
JPMorgan’s Marko Kolanovic weighed in on Tuesday afternoon, with his own trenchant assessment, which included his near-term outlook for the market in light of geopolitical events, flow catalysts and the rotations seen over the past several sessions. Here’s a simple visual from Goldman which gives you a kind of 30,000-foot view of what’s transpired:
One of the points McElligott was keen to make last week and especially on Monday morning before things really accelerated, is that the rates story matters for equities – a lot.
Equity expressions of the duration infatuation have dominated consensual positioning, so any reversal of the rates rally (and especially any action involving bear steepening) risks triggering unwinds in long duration bond proxies and concurrent rallies in beaten-down laggards (e.g., Value and cyclical names).
Goldman underscores this in the note mentioned here at the outset. “Our recent Factor Barometer shows Momentum and Volatility are both significantly inversely correlated to rates currently (~-50-55%; < 5th %ile vs history), suggesting the recent backup in rates has been a likely catalyst”, the bank says.
In a separate note, the bank’s Peter Oppenheimer expresses some skepticism about the sustainability of the rotation, even as he admits that due to extreme crowding, fleeting reversals can manifest themselves in dramatic moves like those witnessed on Monday.
“A rise in bond yields is accompanying the rotation that we have seen in the past few days [and] for markets to change leadership, we need to see an improvement in sequential growth expectations, higher bond yields and lower policy uncertainty”, Oppenheimer remarked on Tuesday evening, on the way to saying that, if you ask Goldman, “this current rotation is unlikely to last structurally if bond yields remain low and growth stays weak”.
Still, as alluded to above, Oppenheimer acknowledges that thanks to extremely lopsided positioning, any near-term catalyst that helps reinvigorate the reflation story (therefore reviving optimism for cyclicals) could see an extension of the “pain trade”. To wit, from Goldman:
Given extreme positioning in ‘momentum’ and quality, any rotation could be powerful even if it is short-lived. The triggers in the short run could be geopolitical: an alleviation of trade worries or the passing of a Brexit deal, for example. It could also come from stronger policy action and any evidence that the sharp downturn in the manufacturing cycle is bottoming out.