The Bubble That Never Pops (It’s Been One Trade For Half A Decade)

“We are in a deep recession, yet the stock market has completely blown it off”, Duke’s Cam Harvey, the godfather of yield curve analysis, told Bloomberg this week, during a podcast.

It’s true. Stocks have “blown it off”, in the process “blowing” through February’s pre-pandemic records to fresh all-time highs, even as concerns over leadership, breadth, and valuations permeate the thick summer air.

It says something about attitudes when the only sign of angst is investors’ preference for the names which have run the furthest. Nowadays, we measure risk appetite by the extent of mega-cap tech’s outperformance. The better the Nasdaq 100 fares in a given session, the more “nervous” market participants are assumed to be. Last week, tech and momentum outperformed small-caps and value by wide margins, reversing the early August pro-cyclical rotation.

Note in the figure (above) that weeks during which momentum and big-cap tech underperform are generally stretches characterized by optimism around the economy, the re-opening push, and/or vaccine news. Not coincidentally, those are also weeks when bond yields rise. Other than those fleeting episodes, the regime essentially never changes — it’s a steady erosion of cyclical value and a relentless grind higher for the Nasdaq 100 and outperformance for momentum.

This marks the culmination of a yearslong dynamic wherein big-cap tech became synonymous with myriad factors and styles, while the whole trade benefited from lower yields and a flatter curve.

It’s the ultimate slap in the face to value investors: “It was a risk-off day” now means overvalued tech names must have hit new highs. “Investors were nervous today” probably means Alphabet, Amazon, and Microsoft trekked a little closer to the $2 trillion valuation threshold, while Apple probably hiked further above that same mind-boggling milestone, which just nine months ago was a mark only attainable by Saudi Aramco, a company whose business model almost literally involves pumping free money out of pipes in the desert.

Underscoring this is the visual (below), which some will surely recognize as the “most crowded trade” list from BofA’s Global Fund Manager survey.

It’s not just that “Long US tech & growth” has been the most crowded trade for eight of the last ten weeks that’s notable. When one views the list through the lens of everything discussed above (i.e., in the context of the never-changing market regime, wherein the vaunted “duration infatuation” in rates feeds into the prevailing trend in equities), it’s clear that the “evolution” of BofA’s “most crowded trade” list is no “evolution” at all. In fact, “the most crowded trade” really hasn’t changed in more than four years.

“Long Quality’, “Long Nasdaq”, “Long FAANG+BAT”, and “Long US Treasuries” are, in one way or another, reflections of the same macro outlook. And one of those trades has been identified as the “most crowded” in nearly every month going back to early 2016.

Sure, the list is sprinkled with a few other things. “Long Bitcoin” and “Short volatility”, for example, reflected the egregious bubbles of the day in late 2017 and early 2018. But other than that, the list can be described as “all one trade” — and for going on half a decade. (Note that the other cameos are very low-conviction, e.g., “Long EM” in February 2019).

This trade (in all its various manifestations, whether you look at valuation disparities, the amount of duration risk embedded in portfolios, factor crowding, or the sheer persistence of the outperformance as illustrated by simple ratios of growth indexes/value indexes) is potentially one of the biggest bubbles in modern history.

The problem is that it never pops.