What happens to the bubble in bond proxies and other crowded trades tethered to a “slow-flation” macro environment in the event yields were to move sharply higher?
How dramatic would the unwind in the long Min Vol./Low Vol./Quality/Momentum versus short Value/Cyclicals trade be if bonds were to sell off hard?
Those two related questions continue to pop up, even as the duration purge takes a pause and bonds stabilize pending resolution of myriad questions around trade and the global economy.
Read more: Is The Min Vol Bubble Bursting?
As a reminder, the divergence between Value stocks on one side and Low Volatility and Momentum stocks on the other side hit extremes never witnessed before late in the summer.
Indeed, the disparity made the tech bubble look like a relative blip by comparison.
(JPMorgan)
As the debate continues amid a lull in the action in rates (i.e., with the 10Y now loitering around 1.80 after making a run at 2% earlier this month), SocGen’s Andrew Lapthorne is out recapping the extent to which performance has been polarized by the proliferation of “bond risk” in equities.
Last month, he notes, the best performing sectors globally were things like Industrial Engineering, IT Hardware and Autos, while Utilities and Real Estate lagged as the pro-cyclical rotation gathered steam. “This polarisation in performance is on the back of rising bond yields and improving economic sentiment, with a clear relationship between a stock’s ‘bond-beta’ and recent performance”, Lapthorne writes.
“Stock sensitivity to bond price movements appears to be rising”, he goes on to say, illustrating the point with the following visual, which shows how sensitive a long US Value/short High-Quality strategy is to changes in 10-year US yields.
(SocGen)
“Currently it is running at 17x, so for every 1bp point move in bond yields the value vs quality strategy is moving 17bp”, Lapthorne remarks, on the way to asking: “What if bond yields were to rise by 100bp?”
Good question. And the next logical thing to ask is whether and to what extent the broader market would be affected by the kind of rotation a 100bp rise in yields would invariably engender under the hood in equities.
In September, when yields surged off the August nadir, a series of multi-standard deviation factor quakes would have gone totally unnoticed to the average investor.
“HILARIOUSLY, nobody watching financial TV or Joe Schmoe retail investor looking at just simple Index returns in isolation would have had ANY idea of the calamity occurring under the surface, as it was all about a blowout in sector- and thematic- dispersion which then acted to offset / ‘mask’ the top down moves”, one popular strategist wrote on September 10.
Hopefully, the good economic data which you’d assume would accompany any sharp move higher in yields would give the attendant pro-cyclical rotation in equities a decidedly bullish “vibe”, helping to offset any indigestion from the inevitable performance bleed that would accompany the bursting of the bubble in High Quality/Min. Vol./Growth/Momentum.
Hopefully. And that assumes that a backup in yields of that magnitude wouldn’t be problematic for stocks in and of itself.
Read more: Armageddon Scenarios, Willful Ignorance And ‘Bond Risk Everywhere’
The question is which bond rates? If it is long rates and you get a steepener that would indicate faster growth. What about 100 bps in the short end and a flattener? Probably not good for any type of equities (fed policy mistake- overtightening)…..In any case the most likely relevant question revolves around credit spreads not necessarily the absolute level of rates- and this correlates with the rate of change in rates across the curve.