Regime Shift In Stocks Screams ‘V-Shaped’ Recovery

Regime Shift In Stocks Screams ‘V-Shaped’ Recovery

It will likely all end in tears – that’s certainly the position of some stubborn skeptics for whom Friday’s monumental rally in US equities was insult to injury.

I’m not sure I’d count myself a “stubborn skeptic” – “plain skeptic” is probably more accurate. I don’t like the idea of paying an indeterminate amount for a dollar of earnings (because there’s not much visibility right now into what profits will look like going forward) but I know better than to doubt the power of the printing press.

You don’t generally want to bet against liquidity-driven markets. I spilled gallons (upon gallons) of digital ink to make that point over the past two months. Betting against central bank largesse has been a fool’s errand in the post-financial crisis world, and the futility of going up against the benefactors with the printing presses is on full display currently.

Of course, it’s not just equities. The Fed is backstopping corporate credit too, and that’s catalyzed record issuance and a tsunami of inflows into investment grade and high yield funds.

In March, it looked briefly like popular credit ETFs were on the verge of “breaking”, as net asset values became detached from prices. The figure simply shows the “V-shaped” recovery in the most popular investment grade product as the Fed stepped in during the height of the panic.

But until recently, the bounce in risk assets had a predictable feel to it. The winners were secular growth and especially big-cap tech, which was seen benefitting from work-at-home arrangements and shifts in consumer preferences tied to the pandemic. Credit spreads snapped back tighter as investors looked to front run eventual Fed buying in corporate bonds. And so on, and so forth.

What’s changed over the past several sessions is that the curve has steepened and cyclicals have taken the baton. Reopening optimism is running rampant, and Friday’s jobs shocker turbocharged the dynamic.

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

This is an especially vexing development for the stubborn skeptic crowd. If cyclicals, small caps, banks, energy, and value shares take off, and long-end yields rise in a benign way indicative of optimism around the growth outlook, it will be more difficult to castigate the rally as just the latest manifestation of the post-financial crisis “slow-flation”, liquidity-driven, melt-up.

A few visuals in this regard are worth highlighting. The iShares Core S&P Small Cap ETF took in $900 million on Thursday, the largest daily haul in years.

XLF (the widely used financial ETF) enjoyed a massive haul this week, while QQQ (the Nasdaq 100 product) witnessed the biggest exodus since October of 2018.

A simple comparison of airline shares (which were up 35% on the week), banks (which rose 17%) and tech tells the story.

The Nasdaq 100’s weekly gain looks wholly pedestrian by comparison. Optimistic investors are now seemingly confident enough in the economic rationale for the rally to put their money where their mouth has been. In other words, folks are now betting on the things that would benefit if the US economy is, in fact, poised to rebound in “V-shaped” fashion.

Perhaps the most amusing manifestation of dip-buying (likely by retail investors), bottom-calling, and reopening optimism, comes courtesy of the “JETS” ETF, which Bloomberg’s Eric Balchunas has spent quite a bit of time marveling at recently.

“All I’m going to say is 66 days and now $1.3 billion”, Eric said Thursday, despite a self-imposed moratorium on tweeting about the product.

The bottom line: Investors are falling out of love with fully-valued secular growth and momentum plays tethered to the assumption that long-end yields will remain subdued in the face of a lackluster economic outlook, and turning instead to “bargains” in all the beaten-down sectors that will surge on an economic renaissance.

It’s a big gamble, that’s for sure. But so is life.


8 thoughts on “Regime Shift In Stocks Screams ‘V-Shaped’ Recovery

  1. Reopening drives job gains, business failures and state/local govt deficits drive job losses.

    There is a timing mismatch. The reopening is underway now (May-June), the PPP money and remaining small biz savings run out later (like, July?). That’s only a month of “V party”-ness, but a month is a long time nowadays.

    If there is a PPP #2 in July, could be more than a month to party. If a second virus wave forces re-closing, the party will end, but most states won’t reclose until reefer trucks are stacked in front of their hospitals, and that will take a couple months – if it happens.

    The biggest problem to me is that so many of the cyclicals are within 10-15% of pre-Covid levels, which means before long we might be still at the party but with no pretty girls/guys to dance with. That means reaching down to uglier and junkier dance partners.

    1. JYL,

      The markets and citizens may need those “reefer” trucks you mention to dull the pain from economic reality.

      Hopefully the hospitals will not need th refrig trucks I believe you meant.

      Think u r spot on on ur analysis.

  2. Bal sheet quality is less important in this rotation based on the assumption “extend and pretend” or more accurately add more debt will be a savior and the bankruptcy risk is lessened. And with better stock prices secondaries can be utilized to hopefully pay down debt. Not sure realists are thinking in terms of better revenue, better margins, more cash flow. Most of corp America still has a debt problem and look likely to have cash flow issues for several years. Thank goodness the Fed has engineered a corp bond market pricing miracle. Credit analysts are not looking at true better credits (unless there is massive equity issuance). It has a whiff of ponzu scheme to me but what does 35 years of professional investment experience matter?

  3. “The power of the printing press ” says it all….On the other hand there is the law of unintended consequences for the rest of us with no printing press .. Am not so sure the printing press has trumped all in my reading of history . Hard to argue with H…..on this one as this dynamic is one that is tough to see objectively from both sides. My skepticism has served me well over the years except these last 5 after about 2016…The best laid plans of mice and men are usually equal …lol

  4. The market initially was skeptical of the Fed bazooka and focused on virus and economic devastation. More recently, consensus has reluctantly capitulated to the liquidity spigot explanations, admittedly helped by less concern of other negatives. The momentum towards the reflation trade is interpreted as validation that the market is looking through the data , the end of the recession is at hand, and the right strategy is to position in early cycle sectors. Against a backdrop of enormous uncertainty one might be well served to be skeptical of any market judgment that begins to have the ring of consensus. Now may actually be the time to fade iit.

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