One of the (many) pressing questions coming off a fraught (or exhilarating, depending on how you want to look at it) first quarter, is this: What will become of the equity rotation?
As bond yields rose and growth optimism proliferated, pandemic winners and stay-at-home favorites became laggards and otherwise underperformed. Or, worse, they morphed into outright losers.
While not all perennial market favorites from the “slow-flation” macro regime were bludgeoned during the pro-cyclical rotation that kicked into high gear following the election, the Nasdaq 100 did fall into a correction during the first quarter and some manifestations of “froth” encountered the bear.
Read more: The Hubris Bear Market Has Arrived
Obviously, the fate of secular growth hangs at least in part on the trajectory of any further backup in yields.
For example, tech’s correlation with 10-year yields in the US was among the most negative in two decades (figure below) at one point last month.
“Especially in the US, there has been a large increase in equity duration with a larger weight in secular growth stocks – those could face a larger drag from higher yields as they benefit less from reflation,” Goldman said, in their latest asset allocation piece.
The bank’s Christian Mueller-Glissmann noted that “the beta of Nasdaq and MSCI World Growth to US 10-year yields has turned deeply negative YTD.”
I doubt I need to further emphasize this (and I don’t mean to rub salt in the wound for anyone who stuck with a tech/growth tilt despite the demonstrable shift in the macro winds), but small-caps beat the Nasdaq 100 by a country mile during the first quarter (figure below).
Indeed, Q1 marked the first time in five years that the Russell 2000 beat the Nasdaq 100 for two consecutive quarters.
Additionally, it was the first time in quite a while that small-caps beat big-cap tech by a double-digit margin two quarters in a row. (The Russell did correct towards the end of Q1, which makes this all the more indeterminate going forward.)
Similarly, value logged a second straight quarter of outperformance versus growth (figure below).
Note how egregious value’s underperformance was during the depths of the pandemic lockdowns and also over the course of the summer 2020 tech melt-up. That suggests there’s still quite a bit of catching up to do, and that’s to say nothing of all the ground lost over what seems like an eternity of underperformance.
Value has spent so long underperforming that some investor cohorts can’t possibly remember a time when growth shares were out of favor. Let’s say you’re 22 years old. You were a toddler (literally) when the tech bubble burst. I reiterate that at regular intervals, mostly because it’s funny.
The updated figure (below) shows how the tail end of a long, painful bad dream for value crescendoed in a parabolic nightmare during COVID, as growth’s outperformance accelerated at an almost unthinkable rate.
Finally, after the election, the trade tipped over under its own weight.
The future for the pro-cyclical rotation depends heavily on the economic outlook and, by extension, on progress towards herd immunity. If you’re curious as to whether there’s still value in… well, in value, SocGen’s Solomon Tadesse reckons there is.
“Reflecting years of disappointing performance, value’s valuation has touched historical lows in the wake of the pandemic crisis, presenting an unparalleled bargain to investors,” he said, in a new note, adding that on the bank’s composite measure of valuation, US value “was trading at a valuation discount of close to 60% vis-à-vis the broad market at the bear-market bottom in March 2020.”
Even after the recent rally, value was still trading at a 51% discount as of the end of Q1 on SocGen’s metric.
Relative to its own history, value “currently trades at an 11% discount [and] is as attractive currently as it was at the depths of the 2008 Financial Crisis when it was trading at a 12% discount,” Tadesse went on to say.
In remarks to Bloomberg last week, Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors, said he sees the rotation continuing. “Moving forward, it’s going to be more about the recovery plays, and that’s not a story that’s going away,” he ventured.
Knock on wood.