It was predictable – or at least it was as it relates to the first few weeks of the new year.
Some manifestations of the pro-cyclical rotation trade which was part and parcel of the market zeitgeist in Q4, have been faded in 2020, in keeping with the 1-month price reversal strategy advocated by the likes of Nomura’s Charlie McElligott in December.
We discussed that in a wider context here, but remember that it was actually a call on a “reversal of the reversal”, if you will. That is, Q4’s pro-cyclical rotation represented a reversal of the vaunted “slow-flation” trade, both in rates and stocks, in favor of higher yields, Value and Cyclicals. January, by contrast, has seen some of that reflation optimism faded via renewed outperformance of the “old” favorites (e.g., Secular Growth, Defensives and Min Vol).
In addition to the safe-haven bid which, at one point, saw 10-year yields fall to ~1.70% in the minutes around Iran’s counterstrikes against US targets in Iraq, there was a bullish seasonal in play for UST futures, which argued in favor of fading the Q4 reflation euphoria – at least tactically.
Now, rallies in familiar places associated with the old “slow-flation” regime are hurting anyone who fell too much in love in the reflation narrative late last year.
“The underlyings are ‘bang-on’ with the thesis and trade I’ve been advocating since late Dec—which is that of a US Equities ‘1m Price Reversal’ strategy to exploit a seasonal rebalancing phenomenon, with [an] additional macro kicker of a positive January seasonality for TY that too would lend itself to reversing the ‘Cyclical / Value / Reflation’ trade that ran wild in December ‘19”, Nomura’s McElligott said Friday, adding the following, which is essentially a recap of the thesis he pounded the table on weeks ago:
And after the 4Q19 “scramble” into “Value / Cyclicals / Reflation” footing on the panicky “re-pricing of growth HIGHER” trade following the US / China trade relief, we have seen Equities L/S HF in particular “purge” themselves from “1Y Momentum” factor sensitivity (L/S Fund “Beta to Momentum” factor at just 0.5th %Ile since 2003), as it was viewed as a relic of +++ “Duration” era benefiting from the prior “end of cycle slowdown / recession” scare.
While there’s plenty of scope for this to turn around (especially in light of the imminent signing of the US/China trade deal and the prospect that the market will find something to like in the details), the first days of the new year have served as a reminder that the vaunted “duration infatuation” may not be such a “relic” after all.
Although long-end yields have bounced back from the Iran panic lows, the safe-haven bid associated with this past week’s geopolitical turmoil is a stark reminder of the potential for bonds to be back in favor in the blink of an eye, especially after the cheapening witnessed in Q4. Additionally, the lackluster December ISM manufacturing print and a lukewarm December jobs report, served notice that even as the US economy looks posed to motor along, we’re from “blasting off like a rocket ship”, to quote Donald Trump.
As Bloomberg’s Sarah Ponczek writes in her own coverage of the same dynamic, “for fund managers analyzing different stock-market characteristics like value and momentum to try to gain an edge, getting exposures right is crucial” on the heels of what, by some measures, was one of the worst relative years in decades.
Of course, not helping matters is the renewed flattening in the curve. Remember, bear steepening is seen as validation of the reflation story. Bull flattening is kryptonite to that narrative.
As McElligott went on to remind folks Friday, the shape of the curve “is the key macro input in performance of Value and Momentum in the post-GFC” era.