The ‘Trillion-Dollar Question’ For US Stocks

Barring a reversal of fortune, 2022 will be remembered as the year the “slow-flation” macro regime died, and with it, the so-called “duration infatuation” that became the de facto consensus trade for nearly all investors, from whales to minnows.

Thankfully, the demise of that trade has been more slow-moving train wreck than overnight collapse. It started with the Cathie Wood complex in early 2021, when bonds staged a dress rehearsal of the historic drawdown that unfolded 12 months later. Around the same time, hedge fund leverage started to fall.

The unwind worked its way inward until it finally undercut the FAAMG cohort, to the detriment of many hedge funds, for whom the word “strategy” had become a polite euphemism for crowding into secular growth names at elevated valuations, ostensibly justified by low rates, central bank asset purchases and a macro regime that made it possible for central banks to persist in monetary accommodation.

The figure (above) shows the top five stocks in Goldman’s “Hedge Fund VIP” basket. And how they’ve fared in 2022.

Ironically (some would say predictably), the gold standard, high-growth names that became almost synonymous with the US equity market, are now fallen angels. Not in any credit-related sense, but conceptually speaking. This is the Icarus trade.

FAAMG’s wings were made of stronger wax than the kinds of hyper-growth, infinity-multiple shares that many critics identify with Wood’s Ark, but eventually, scorching inflation and the attendant rise in rates melted even the mightiest tech titans. At the same time, many left-for-dead cyclicals and “old economy” names came roaring back to life, with energy shares among the most poignant examples.

Now, some wonder if the unwind has gone too far for growth, tech and consumer discretionary, to name a few. A corollary asks if this year’s leadership is due for a correction of its own.

The figure (above) is deliberately simplistic. It’s meant to capture the nascent bounce in some of 2022’s most beleaguered shares in a way that’s easy for all readers to grasp.

This is very topical. Take Thursday’s rally, for instance. It’s “old” news now, but only because Elon Musk’s “super bad feeling” about the economy overshadowed nearly all other concerns on Friday. In the two tables (below) the green boxes show Thursday’s one-day return, and the red boxes the QTD and YTD returns for a given group of stocks.

Again, Friday’s Musk-inspired selloff torpedoed Tesla, with knock-on effects for a lot of what led Thursday’s rally, but the to-and-fro exemplifies the question: Is the massive YTD performance bleed illustrated in the red boxes (above) enough, just the beginning or simply a reset to more “sane” valuations for names where there’s “something there” (so to speak) and a well-deserved demolition in market segments that were mostly “froth” to begin with?

Nomura’s Charlie McElligott posed it as a two-part, “trillion-dollar question”:

Was the violent rally in ‘trash,’ shorts and YTD losers that went bonkers Thursday against YTD ‘winners’ turning underperformers a sign of simple further de-grossing from clients covering shorts and selling longs from the YTD thematic trade? Or, conversely, was this enormous explosion in ‘high-multiple’ speculative stuff a more constructive development with investors beginning to re-deploy, and an evolution towards a ‘tradable bottom?’

Obviously, the hangover following market tops is defined by rotations into defensives and other traditionally “safe” market segments. Due to the nature of the macro shift that catalyzed the current selloff, there’s an amusing, idiosyncratic dynamic at work defined by the realization that mega-cap tech, far from being safe, is actually the last place you want to be as the long-duration trade unwinds, while supposedly “dead” energy and cyclical value shares are the unlikely safe spaces.

I’d be remiss not to note the distinct possibility that the FAAMG cohort is having a “baby with the bathwater” moment. The purge in speculative, profitless tech has understandably swept up high-multiple growth stocks, but Amazon isn’t Peloton. And Google isn’t some fly-by-night SPAC merger.

In any event, McElligott went on to talk a bit about the possibility (he didn’t take a side on this, he merely discussed it) that the last two weeks were indicative of a “bottoming process” in some of the most beaten-down market segments.

During such periods, “you see funds begin to redeploy again into ‘cheap’ stuff, which in this case — especially after the rally in ‘safety’ and Quality, which got ironically expensive — means that some investors are holding their noses and buying junky ‘fallen angels’ in the duration-proxy FAANG+-, mega-cap tech-, Growth-, Leverage-, Low Profitability–universe.”

If you’re wondering whether there’s any evidence for that outside of the rebound off the lows in besieged sectors, segments and styles, the answer is “yes.” On Thursday, the infamous “spot up / vol up” dynamic could be observed in benchmarks, ETFs and some single-names. “If people are nibbling again on these beaten-down names, it would make sense that they too began buying some hedges again,” McElligott said.

Earlier this week, JPMorgan’s Marko Kolanovic noted that “some market segments [like] defensives and staples are trading near all-time-high relative valuations, while other market segments are trading near all-time-low relative valuations.” Given that, “the most attractive investment opportunities” may be “in these oversold sectors that provide asymmetric upside,” he said.