If you’re looking to hear the story of 2021 (for markets, I mean) you should consult the curve.
For years, the “slow-flation” economic environment and the implications of that macro regime for duration, dictated persistent outperformance for secular growth at the expense of cyclical value. This is a familiar story to regular readers.
While there are innumerable ways to visualize the situation, a simple chart of growth relative to value shows how grinding, perennial outperformance went parabolic in 2020 thanks to pandemic dynamics, and then reversed sharply after the election as market participants began to price in regime change (figuratively and literally).
In a Monday note, Nomura’s Charlie McElligott wrote that “the recent bear steepening in Treasury curves on account of the upgrading in economic expectations (particularly ‘inflation’) has single-handedly told the tale of 2021.”
What is that tale? It’s “an ‘unwind’ of the legacy ‘long duration, short cyclicality’ trade.” McElligott called it a “pure Anti-Long-Term Momentum” dynamic, characterized by explosive moves higher in placeholder shorts and “massive” underperformance from secular growth, min vol and mega-caps.
I should emphasize that the figure (below) is for illustrative purposes only. That is: It’s meant to get the general point across and isn’t necessarily indicative of the “best” or most accurate way to chart the dynamic. As ever, I try to choose poignant images that are relatively easy for everyday readers to digest.
The crucial bit to understand is the extent to which this is driven by rates and the curve.
McElligott noted the “extreme correlations being witnessed between assets, industries, sectors and UST 10-year yields.” For example, tech’s rolling 21-day correlation is in the 1.6%ile going back more than three decades.
So, it’s not just that the bond selloff matters as a macro signal. Don’t think of the backup in yields solely as an inflation signal or an indicator of the market’s expectations for growth. It’s that, yes, but because the old macro regime was so entrenched across assets, a shift in that regime (as heralded by yields and the curve) means the ripple effect will be especially dramatic.
As far as the backdrop post-Op-Ex goes, McElligott on Monday said “QQQ in particular is now ‘extreme negative $Delta’ again, while the market / SPX is much less ‘long Gamma’ now, but in QQQ and IWM options, we’re back to outright ‘short Gamma vs spot'” territory.
What about the vol control crowd? The jump in trailing realized means they’re still “catching up,” if you like, where that means an ongoing “bleed out” of some equities exposure, as Charlie put it. Nomura’s vol control model shows more than $30 billion in selling over the past month. That said, McElligott wrote that “by the end of this upcoming week, we would anticipate VC turning meaningful buyers, as a number of large ‘down days’ drop out of the 1-month realized vol lookback window.”