It was a tough week for global equities. Stocks were on track for their worst showing since March ahead of what, for many in the US, will be a two-week vacation into Labor Day.
Concerns around a shadow banking meltdown in China tied to renewed stress in the property sector were the proximate cause of market participants’ consternation, but new highs for US yields didn’t help and some remain concerned about US economic resilience, which traders worry may keep the Fed biased towards an additional rate hike.
More important, I think, than whether terminal is here or 25bps higher for the Fed, is the specter of “higher for longer,” which is conspiring with the reals-led Treasury selloff to weigh on stocks, both psychologically and mechanically. The figure below is as of August 17.
The recent move is pretty much all reals. That’s a very onerous headwind for equities that’ve run sharply higher purely on multiple expansion. 10-year reals are up 30bps this month alone.
JPMorgan pointed to evidence of clients rotating out of SPY and the Invesco S&P 500 Equal Weight ETF since June. The figure on the left, below, illustrates the point.
To the extent investors began to favor the equal-weighted product earlier this summer, it was probably a bet on the rally broadening out. Or at least initially. Now, though, any such rotation could be a risk-mitigation strategy given the headwind from higher yields for the long-duration growth stocks that dominate the cap-weighted benchmark.
“From a flow perspective, what has been more striking since the beginning of June is the acceleration of the inflow into the equally-weighted S&P 500 ETF,” Nikolaos Panigirtzoglou wrote. “This rotation is still ongoing from a flow perspective [and] the positive flow impulse is ‘genuine’ — i.e. its ETF share creation has not been the result of rising short interest.”
Panigirtzoglou suggested that flow rotation “poses downside risks for tech stocks that have been largely driving this year’s outperformance of the market cap-weighted S&P.”
For richly-valued shares, both 10- and 30-year US reals with a 2-handle are a pretty high bar, and then there’s USD cash yielding 5% or better (nominal, obviously). The risk-reward with expensive equities is questionable at best.
In the “near-term” this is really “simple,” BofA’s Michael Hartnett said. A “clean thrust in 10-year US yields above 4.30% [and] the Chinese yuan weaker than 7.30 equals risk-off,” he wrote, suggesting the S&P may test 4,200 unless “critical bond and FX levels are defended via Jackson Hole.”
On the bright side, trend-following systematic strats have already sold+. “[The] good news is that at least for US equities” the next sell triggers for CTAs are “far out-of-the money,” Nomura’s Charlie McElligott wrote Friday. For the S&P, the level is 4,188.
“The largest equities buy flow potential at this juncture is simply monetization of downside hedges, which have obviously gone hugely in-the-money of late,” Charlie went on, noting that “the issue remains Asset Manager length” which is sitting near the 97%ile across US equities futures. “I think [that’s] showing up in single-name tech leadership getting blown out as they try to shrink.”
