‘It’s All About The Future’ (Here Comes The Pain Trade)

Earlier this week, Nomura’s Charlie McElligott noted that in order for the current rebalancing away from secular growth and duration equities into cyclicals and high beta to morph into a true “rotation”, rates would have to play along.

“The ‘true’ accelerant for a potentially larger shift… 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 wrote. (I should note that as of his last note, McElligott still suggested the rotation would be faded into month-end after a continuation of the rally into options expiry.)

Needless to say, Friday’s blowout jobs report added fuel to the fire for the selloff in rates, as bond bears are emboldened by the prospect of a rapid economic recovery. Yields were cheaper across the curve, with the 2s10s steepening dramatically.

This underscores one of the key points I’ve pounded the table on for weeks – namely that if the economy were to “realize” a “V-shaped” recovery against a backdrop characterized by massive fiscal stimulus, yields could rise quickly, and the rotation into cyclical value in equities could be extreme indeed.

“[The] biggest summer pain trade is a disorderly rise in government bond yields”, BofA’s Michael Hartnett wrote Thursday, adding that the late-60s early 70s were likewise a “period of social and civil unrest, bigger government/budget deficits, rising yields and inflation, after a long period of calm”.

This coincided with “three big, simple trends”, he went on to say, citing rising bonds yields, a falling dollar and “volatile, sideways stocks”.

(BofA) 

Irrespective of what you think is likely to happen over the medium-term, the very near-term implication of rampant optimism around reopenings and now a shocking upside surprise on the May jobs report, is a continuation of the pro-cyclical rotation.

This is manifesting in a big way, as Friday’s moves built on a shift that was already in motion.

The flip side of that rather astounding visual is a blowup in the momentum factor.

The figure (below) shows that at one juncture, Friday was the worst day for the Dow Jones market neutral momentum portfolio in almost two decades.

As I put it on Wednesday, if 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 “real” bear steepening impulse which in turn breathes life into a long-dead trade.

Value, cyclicals and small-caps favored over secular growth, min. vol., and other equities expressions tethered to the duration trade in rates, is precisely that “long-dead trade”.

“[The] best buy in stocks is either EM (dollar peaking) or small cap value”, BofA’s Hartnett ventured on Thursday, noting that the Russell 2000 is still down markedly from this year’s highs and would benefit materially from a successful reopening push.

Small-caps are on track for a third consecutive week of outperformance versus the Nasdaq 100.

As one portfolio manager told Bloomberg on Friday, “it’s all about the future and we are coming out of the storm”.

Famous last words?

Read more: Six Months From Now, We’ll Know Who Was Disastrously Wrong