All That Matters

Monday was instructive for anyone who still doesn’t understand the dynamic currently governing markets.

US 10-year yields dropped for the first day in five and tech stocks surged, even as equities gave some back into the close on Wall Street.

The long-end led the rally, bull flattening the curve. The Nasdaq 100 jumped by nearly 2%.

That isn’t a coincidence. Treasurys didn’t “hold gains despite buoyant stocks.” Rather, stocks were buoyant because bonds were bid.

As illustrated rather poignantly in “The Curve ‘Has Single-Handedly Told The Tale Of 2021’,” the correlation between big tech and bonds currently sits in just 1.6%ile going back more than three decades.

Any reprieve from the backup at the long-end is welcome in a general sense, but it’s a veritable godsend for secular growth and big tech which, since the election, found itself in extremely unfamiliar territory as a market laggard. As yields rose and curves steepened, growth underperformed.

The “problem” with that is simple: Market leadership is extremely concentrated. So, when you get underperformance from tech, benchmarks can struggle due to years of accumulated concentration.

Although Goldman reminded market participants that “the extraordinary success [tech] companies have achieved is not uncommon in periods of rapid technological change as a few players become the standard,” it’s nevertheless notable that the FAAMG cohort is now twice the size of the Topix and three times the size of India’s annual economic output.

In may not be unusual in a historical context (indeed, Finance & Real Estate and Transportation were far more dominant in the 1800s than Info Tech and Comms Services are today), but it still means that when the titans are under pressure, it’s a drag on the entire market.

Again (and I always feel compelled to emphasize this): There’s a good reason why the FAAMG cohort is so beloved. As Goldman wrote Monday, “FAAMG companies have seen roughly 3x the average sales growth of the rest of the market and 2x the average net income growth in recent years.”

The problem isn’t whether there’s a “rationale.” And nobody is suggesting that history isn’t replete with instances of extreme concentration, either by an industry, a sector or even a single company.

Rather, the issue is the correlation between the leaders and bonds. And the attendant read-through of the duration selloff for benchmarks dominated by those leaders. The figure (below) drives home the point.

“As the US experiment with run-it-hot economics spurs the demise of the long-dated Treasury bull market, strategies tied to the low-rate era look dangerous,” Bloomberg’s Justina Lee wrote, in a good piece dated Monday. “While the Treasury rout has been taking place for good economic reasons — juicing trades that ride the business cycle — some of the biggest market winners of the past year still look vulnerable.”

This is all that matters right now. The previous market leadership needs to somehow find “peace” with higher yields so that tech can stabilize. That way, new leadership from cyclical value isn’t just spending its days trying to backfill losses in secular growth.

BMO’s Ian Lyngen and Ben Jeffery suggested on Monday afternoon that “10-year yields reached 1.75% and have shifted into a period of consolidation with a slight bull flattening skew.” If that’s the case, it would be a welcome development. They also noted that “the flattening follows intuitively given the bulk of the supply this week is concentrated in the 2- and 5-year sectors.”

Of course, if a disorderly bear steepener is the worst-case scenario, a bear flattener predicated on market angst about the Fed being forced to hike sooner than the Committee expects is almost equally unpalatable.

And then there’s the seven-year sale. The dreaded seven. “The uncharacteristic relevance of the sector hasn’t escaped us,” Lyngen and Jeffery remarked. “Even if the solid reception to the 20-year takes away some of the potential market-moving implications from the results.”