The steepening impulse in the curve is starting to get some serious traction, with the 5s30s hitting 2016 wides on Wednesday.
This is feeding the pro-cyclical trade and emboldening those who dare to suggest we’ve reached a pivotal moment – that the elusive “rotation” is upon us.
“Depending on the velocity of the expected ‘risk-on’ move over the coming two weeks into Op-Ex, the US Equities focal point will continue to be on the recent ‘spasms’ of thematic rebalancing into structurally underweighted Value factors”, Nomura’s Charlie McElligott said Wednesday.
Despite the Nasdaq gunning for a new record high as part of the generalized risk-on move across global equities, McElligott notes that crowded bond proxies like secular growth, defensives, and min. vol., will continue to be a “source of funds”, especially after having run as far as they have.
This is the same story from “The Only Debate That Matters“. As the data improves, and the market gets the idea that in addition to being more rapid than expected, the recovery will be turbocharged by fiscal stimulus, it’s possible you get a move higher in inflation expectations and a “real” bear steepening impulse which in turn breathes life into a long-dead trade.
The Russell 2000 has outperformed big-cap tech in eight of the last 10 sessions.
“Many of these previously ‘left for dead’ equities have beta/convexity to upside in economic growth or inflation, which is why in the era of ‘Goldilocks slow-flation’ they have been placeholder shorts/underweights for the better part of a decade”, McElligott goes on to remind you.
Crude’s ongoing rebound following April’s surreal trip into a parallel universe (where oil is worth less than nothing), is helping this trade along.
Over the past year, the long-running secular growth over cyclical/value bent performed especially well even by the standards of a trade that’s been working for quite a while.
As McElligott notes, the one-year factor performance numbers shown below were courtesy of the “enormous rally in US Rates / USTs, due to the Fed’s capitulation back to the zero lower-bound, QE [and] large-scale asset purchases, and even more acutely from this year’s global economic simultaneous ‘left tails’ from COVID-19 and the oil price war”.
Compare the one-year columns to the MTD performance, and you can see signs of the rotation.
Although it seems counterintuitive to suggest that the tide may finally turn in favor of value, cyclicals, and high beta during the middle of a modern day depression, you should note that it’s predicated on the notion that the economy inflects faster than expected, and that once it does, trillions in stimulus (both monetary and fiscal) will usher in a new era of more robust growth and inflation outcomes across developed markets.
But, in order for this to happen, rates have to play along, something McElligott underscores.
“The ‘true’ accelerant for a potentially larger shift from the current ‘rebalancing’ into an outright rotation away from Duration Equities towards Cyclicals… would be an inflection away from the multi-year long built into Global Fixed Income positioning, particularly within managed futures / CTAs as typical ‘first movers’ on trend breakdown or reversal”, he writes.
That doesn’t appear to be imminent – or at least not for US rates.
“The ‘+100% Long’ UST 10Y futures signal within our CTA model remains deeply in-the-money, far from deleveraging triggers, and somewhat bullet-proof for now“, Charlie says, with an emphasis on “for now”. This is in part attributable to the relative attractiveness of the US long-end, which becomes even more tantalizing for FX-hedged foreign investors on any cheapening.
That said, some steadfastly contend that the market is underappreciating the potential for a rapid economic recovery to collide with the largest, global coordinated stimulus in history to catalyze a sharp move higher in inflation expectations, and an epochal rotation to all the equities expressions that would benefit from a tectonic shift to a world defined by fiscal-monetary policy coordination on a massive scale. (See: “What If (Almost) Everybody Is Wrong?“)
Pick a side.
[Note: McElligott’s sequencing for June generally sees a pullback from any cyclical rotation and a post-Op-Ex tilt back towards a defensive bent into month-end]