It’s been “a while” since the imperative to own cyclicality was as strong as it is currently.
That’s according to SocGen’s Andrew Lapthorne who, in a new note, emphasized the extent to which the Nasdaq 100 and the S&P are “struggling” to digest higher bond yields.
I spent a good portion of Monday (here and here) reconnecting the dots for folks who might just now be coming around to why it is that rising yields are problematic for benchmarks skewed towards mega-cap tech heavyweights.
Two figures underscore the point. The correlation between 10-year yields and US tech (on the left, below) is extreme, while the stock-bond correlation in the US has flipped positive (right pane below).
This is a vexing issue in an environment when yields are rising and markets accustomed to leadership from duration-sensitive assets are suddenly compelled to cope with an aggressive rotation to cyclical value shares.
SocGen constructed sample portfolios with the US bond weight set at 40%. The equity allocation varied, split between the S&P 500, Global Value and a “Global Inflation basket.”
As Lapthorne noted, the value and inflation components “act nicely as bond risk diversifiers.” “Whether we were trying to limit the drawdown, or the volatility, or maximize the return versus risk profile, the low weighting in the S&P 500 this year is notable,” he said.
The problem with eschewing sectors and styles poised to benefit from the assumed economic renaissance in favor of legacy “winners” in tech, growth, min vol and quality (and many of those are synonymous with pandemic favorites) isn’t just the risk of forgoing participation in a panicked re-rating in beaten down cyclicals as the recovery gathers steam. Investors are also taking on considerable de-rating risk due to nosebleed multiples.
While FAAMG valuations (for example) look favorable when compared to the dot-com bubble and the Nifty Fifty, they’re still elevated. As a group, the forward P/E is 25.8 (figure below from Goldman).
“Not only do Growth and Quality stocks miss out on the cyclical EPS momentum, but rising bond yields represent a problem for overall valuations,” SocGen’s Lapthorne went on to say, noting that “buying stocks that are cheaper than average should then protect you more versus say more expensive Growth and Quality stocks.”
Even after recent tumult, the Nasdaq 100 still traded at roughly 26X.
At least in March, 2000, the 10 yr UST yielded about 6%.
Without further clarity on where rates are going (and why), at least SPY has a dividend yield approximately equal to the current 10 yr UST yield.
There is a lot of money floating around out there, and moving from SPY to bonds sounds overly cautious (and boring)…..no doubt, I recognize I might have to “eat my words”, but I will take that risk.
What is so hilarious is that real rates are still negative and will probably be negative for far longer than any of us care to admit.
The longer bond $TLT is an amazing lesson on negative convexity. Nominal rates will have to be a lot higher before I would consider buying bonds.
Look at the sector ETFs over the past week. The worst performing are highly cyclical XLE XLF and the best are XLP XLY which are anti-cyclical since XLY is dominated by AMZN. Cyclical XLB and XLI have also underperformed SPY. All the cyclical sector ETFs just mentioned have underperformed QQQ in the past week.
Look at the style indicies over the past week. Large value RLV-RUX has underperformed growth RLG-RUX, small value has RUJ-RUX has underperformed growth RUO-RUX, and not by a little.
You’re talking about one week that included an oil price collapse.
Andrew is talking about the broader macro picture. Cyclical value has crushed secular growth since the election. XLE outperformed QQQ by 22 (!) percentage points in February. And you’re talking about last week?
And, yes, into month- / quarter-end you could well see a reversal in favor of QQQ if rebalancing flows help stabilize the long-end in rates.
Below is from Charlie M.:
“Hints of potential (much-hyped) qtr-end rebalancing flows, with recent trend reversals seen across assets / themes (which some I believe are misinterpreting as “risk off” flows): Bonds are yet-again bull-flattening (Asian RM buying again, with selling in the front-end), broad Equities lower (but with NQ o/p RTY on the aforementioned UST / duration “bid”), while Commodities (and particular Crude Oil -3.9%) are trading sharply weaker against another blast of broad USD strength”
And here’s YTD from Charlie:
“Cyclical Value” factor +32.4% YTD
“Leverage” +22.7%
“Short Interest” +8.4%
“LT Momentum” -4.7%
“(Secular) Growth” -6.6%
“HF Crowding” -7.9%
“Quality” -8.05
“Low Risk” -18.4%
“Size” (Big-Small) -20.7%
Yes, I know the 1 week performance is very different from the YTD performance.
I’ve been positioned + cyclical, + small, + value, and lately also + cash, so I am pleased to read comments such as Charlie M’s.
However, it’s worth thinking about how that positioning could be wrong.
Some possibilities:
1) cyclical is overbought (yup but that’s getting taken care of),
2) cyclical is overvalued (nope, another 20-50% to go depending on name),
3) stimulus won’t stimulate (short-term effect, how $1400 gets spent was never going to matter beyond a few weeks),
4) rising rates will knee-cap 2H21 econ recovery (seems unlikely that 10Y at – gasp – 2% is enough to knee-cap anything but an unlucky hedge fund, but jury’s out I suppose),
5) Covid will knee-cap recovery (that’s the Euro lockdown fear, investors can now obsess over every wiggle in data to guess if US lockdown is next),
6) rising rates or other will cause something in the black box of options/risk parity/vol trading/etc to come “unstuck” with broad effect (very hard for one not inside the black box to see that coming, so next best is to interrogate every market move to guess if those are unsticking sounds we hear)
I think the B of A survey respondents put Covid in the rear view mirror too soon. The virus remains able to muster a fourth surge, and if that happens it will be more of a threat to portfolios than another 25 bp on the 10Y. I used to be on that panel, and I’d have left Covid at the #1 risk spot.
Good color