Over the past several days, I’ve expended an enormous (some might call it “inordinate”) amount of energy documenting “under-the-hood” action in US equities, where a dramatic rotation was afoot.
As important as it always is to look below the surface for clues as to the “flavor” of the action, such inspections are even more crucial now, given that the pro-cyclical bent evident in markets is indicative of the overall reopening narrative behind what is, on some accounts, a new equity mania in the US. (Tuesday’s pullback notwithstanding.)
Rising long-end yields, outperformance from cyclical value, and surging crude prices were all indicative of optimism around the “V-shaped” recovery narrative. Once that trade got moving in the “right” (or “wrong”, depending on how you were positioned) direction, it catalyzed a dramatic rotation out of long-time, secular growth winners and into long-suffering sectors and styles.
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This has manifested in all manner of multi-standard deviation rotations and extreme market-neutral factor volatility.
For example, have a look at MTD returns for a handful of key factors that have witnessed dramatic moves.
“It seems clear that based on the scale of US equities factor market-neutral volatility in recent days, that we have witnessed stop-outs in many legacy trades [and] across hedges from index/ ETF to short books in general”, Nomura’s Charlie McElligott said Tuesday, adding that Monday had the “feel of ‘peak-capitulation’ from a risk-management perspective”.
Again, this is all coming amid a rapid steepening move in the curve, which has perpetuated the value surge and the momentum massacre.
“This extreme valuation stretch is creating unprecedented cross-sectional factor volatility, with most institutional managers underweight Value and Long Quality/Growth”, SocGen’s Andrew Lapthorne said Monday, adding that “value rallies are often violent, but… buying low price-to- book stocks without such a heavy bias toward bad-balance sheets has also proved an excellent recovery play”.
(SocGen)
To be clear, this has been very acute in nature. The adjective “extreme” doesn’t quite cover it. In fact, 10-day realized vol. in the 1Y Price Momentum Factor tracked by Nomura surged to 150, McElligott notes, underscoring the point.
(Nomura, BBG)
If you’re wondering where that falls on the “swan” scale (so to speak), it’s a 14-sigma move (see the all-caps caption in the right pane).
This “life versus death battle” (as Charlie describes it on Tuesday), has been raging for a decade, and it’s clear “who” has generally prevailed.
Now, the combination of optimism around a quick recovery and massive new government bond supply to fund stimulus, has pushed the curve steeper, and that, in turn, forced and perpetuated the dramatic rotations and unwinds shown above.
Tuesday looks to see all of this reversing course a bit, as the entire narrative takes a breather.
“As I’ve stated nearly every week for a decade, the life vs death battle that has become ‘Momentum ON / Momentum OFF’ from a macro catalyst perspective, is predominately tied to the shape of the yield curve”, McElligott goes on to say Tuesday, pounding the proverbial table.
“[The] deeply-cyclical and economically-sensitive ‘Value’ factor (which are decade-long ‘Momentum Shorts’ for the most-part) is highly positively correlated to a bear-steepening in yield curves”, he adds, before reminding you that bear steepening is often associated with (and seen as confirmatory of) a reflationary macro narrative characterized by expectations of above-trend growth.
That, he writes, “is what we’ve experienced since the March post ‘double-left-tail’ lows”, after which the COVID curve flattened while the reopening (i.e., mobility) curve steepened. The latter finally worked its way through to a “curve” market participants are more familiar with.
The virus seems unconcerned.