We’re All Cathie Wood

At this point, it almost feels gratuitous to deliver more play-by-play commentary on the recent trials and tribulations of Cathie Wood, whose funds have suffered in an environment of higher yields and heightened inflation expectations.

And yet, because Ark is synonymous with the kind of “hyper-growth” names bearing the brunt of the rates pain in the equities space, mentioning Wood is obligatory.

Ark ETFs witnessed a one-week outflow of roughly $1 billion as inflation concerns mounted and market participants were subjected to the hottest CPI read in decades. “Rising inflation draws attention to [the] relatively high valuations of [the funds’] holdings,” Bloomberg’s Kyoungwha Kim wrote, noting that “options and short interest suggest investors are betting on more losses for Ark’s flagship ETF.”

This is quite simple, really. The more attention the inflation story gets, the more scrutiny richly-valued corners of the market will receive. That means high-flying growth shares are under the microscope every, single session. Wood is “high-flying” and “growth” personified.

One of the most notable takeaways from the May vintage of BofA’s Global Fund Manager survey was an all-time low z-score for respondents’ tech allocation (figure below).

That comes “as tech’s weighting has risen to 32% in the [All-Country World Index] from 15% in 2006,” BofA’s Michael Hartnett observed. The flipside (in the survey) was a “massive” overweight in “late cyclicals,” as respondents lean into banks, energy and materials. The most crowded trades were long Bitcoin and long Tech.

The general sense is that in the event inflation fears are confirmed, the re-positioning risk (as exemplified by legacy crowding into all things duration-linked) is enormous. Indeed, it’s almost unfathomable.

An unwind across all manifestations of the “duration infatuation” trade, from secular growth to mega-cap tech to investment grade credit, would be impossible for the market to digest with anything that even approximates alacrity. And that’s to say nothing of the gross mispricings that persist across virtually all DM government bond markets.

“Despite lower real rates, the rotation out of tech stocks has continued – the performance of Nasdaq relative to the S&P 500 has decoupled from real rates which it tends to be closely linked to historically,” Goldman’s Christian Mueller-Glissmann said.

Although Goldman’s longer-term outlook isn’t affected by April CPI, higher realized inflation in the near-term “represents a key risk for multi-asset portfolios as both equities and bonds might suffer in this scenario,” the bank reiterated, in a Monday note.

The stock-bond return correlation is the most positive in decades (on a 60-day window). In a note dated late last week, SocGen’s Sandrine Ungari called the equity-rates correlation that investors have come to take for granted “unreliable.”

You’ll probably claim that isn’t news to you. You’re likely inclined to declare yourself fully apprised of the extent to which bonds aren’t always “your hedge” in an equities selloff. But if the correlation between the two assets flipped on a sustained basis, it would likely play havoc with your portfolio, whether you realize it or not. Indeed, some textbooks would need to be tweaked in such a scenario.

The figure (below, from SocGen) shows 30-year yield changes going back to 1977. “Yields mostly rally when the S&P 500 experiences a large selloff (say 15% or more in a three-month period), but there are times when they don’t and rise instead,” Ungari said.

“We may be in one such regime,” she went on to remark, adding that the red dots in the figure (which show long-dated rates rising as equities fall) clearly illustrate that bonds can “exacerbate rather than mitigate equity losses,” and going forward, it might be prudent for investors to “think of equities and rates as at best uncorrelated rather than anti-correlated asset classes.” (Gasp!)

All of this is disconcerting, and not because it’s written in stone somewhere that the correlations and macro inputs we’ve become so accustomed to over the past two decades represent immutable laws and therefore seeing them violated is an affront to humanity.

Rather, it’s disconcerting because, due in part to recency bias, we treated them as if they were immutable and used them to construct an elaborate market infrastructure that may malfunction if the correlations flip and the inputs change. In a sense, we’re all Cathie Wood.