Zeitgeist Unchanged

There were signs early Friday that the mood underlying Thursday’s session might be poised to continue.

Treasurys extended gains after the previous session’s sharp bull-flattening, suggesting risk-aversion and, perhaps, the beginnings of forced buying into the rally. Five-year yields hit a new record low and 30-year yields were richer by 5bps to the lowest since May 15. 10-year yields were below 0.60%.

I talked a bit on Thursday about the prospects of a “growth scare” dynamic taking hold as re-opening optimism fades with rising caseloads and, now, record deaths and hospitalizations across multiple “hotspot” states in the US.

Read more: Is The Market Sleepwalking Into A Summer Growth Scare?

As discussed at some length in that linked post, a blistering 30-year auction looks to have deep-sixed the steepener in the near-term, and that has ramifications across the equities complex.

“Thursday’s price action brought the curve to almost its flattest level in several weeks. For 2s/10s, we’re watching 45bp as an area which has provided support on multiple occasions since early May”, BMO remarked on Friday, adding that “both 2s/10s and 5s/30s are currently testing the bottom end of their two standard deviation trading envelopes”.

When bonds rally and the curve flattens, it’s a signal to equities that the growth outlook is deteriorating.

To be sure, that can be a “false optic” at times (e.g., when convexity flows cause an overshoot to the downside on yields, with last August being a good example). But, for years, the duration trade and a flatter curve has been synonymous with outperformance in secular growth, which is itself synonymous with tech.

You have to think about this in the context of the pandemic, which has changed consumer behaviors, possibly forever. Although there are plenty of folks who will dispute that, the visual in the bottom pane of the figure (above) speaks for itself.

“Much stems from tech’s new role as a utility — something consumers and businesses simply can’t live without”, one fund manager at AllianceBernstein wrote this week. “These necessities have become even greater as the pandemic increased the need for remote shopping, learning and working”.

This all works against the pro-cyclical trade and also against the return of Value as a viable investing strategy (see “The Only Debate That Matters“).

How many times have you heard that a rotation is just around the corner? Or that Value is on the brink of making a comeback? Or that Min. Vol./Growth is a bubble? You’ve probably heard those arguments (or some derivation) more times than you can count.

And yet, each and every time it looks as though the tide is turning, something short-circuits the rotation, which is seemingly doomed to a fate of being always “nascent” and/or “burgeoning” and never “entrenched”. The latest example is illustrated rather poignantly in the visual (below).

The fact is, Value, Cyclicals, and High Beta just aren’t going to work until there are convincing signs that the economy is on track.

Recent news flow conveys the opposite of that. Indeed, the re-opening is on hold (to a greater or lesser degree) across states which together account for the majority of the US population.

That kind of news flow engenders macro concerns, which spill over into rates, pushing long-end yields lower, bull-flattening the curve. Thanks to years of conditioning, this mechanically leads to predictable factor rotations, which in turn propel bond proxies.

You can see why big-cap tech is seemingly unstoppable in this environment. That’s where the growth is concentrated. That’s where the name recognition is. That’s where the momentum is. And, now, the same titans which account for some 21% of the S&P 500’s market cap are also synonymous with utilities.

This kind of “factor crowding” (whereby the same handful of companies can theoretically be classified as Min. Vol., Growth, Momentum, etc.) leads to their inclusion in all manner of “smart beta” products, which just channels more money into the same handful of shares. Because the most popular indexing strategies track cap-weighted indices, periods of inflows into equity funds tend to disproportionately benefit these names. And around we go.

This is your “perpetual motion machine”. The pandemic and the macro environment the virus has created only serve to turbocharge it.