It’s risk-parity heaven right now, notes RBC's head of cross-asset strategy Charlie McElligott, with global equities (developed and EM) AND fixed-income all continuing their torrid rallies, but McElligott warns this is a classic "from worst to first" PM-grabbing into a new "Fear Of Missing Out" stage of the equities-rally.
Bonds remain well-bid on account of the ongoing ‘slowing into tightening’ narrative, with commodities being the only asset class (outside of volatility, of course) that is lower overnight as a ‘signal’ for the lower bond yields. This continues to be “falling inflation expectations” story for rates / bonds: industrial metals continue their struggles (Chinese / PBoC deleveraging efforts, while recent efforts at STRENGTHENING yuan to stem FX outflows will FURTHER FEED global disinflation in coming months) in conjunction with Crude’s inability to get off the mat post disappointing OPEC (market still focusing on US shale supply--especially now, with the thinking post Trump’s Paris Accord drop-out that we’ll see even MORE US oil supply via increased drilling / deregulation).
#FOMOROTATION: But today is largely an equities-centric story, as stocks can of course view the world in a ‘mutually-exclusive’ fashion from the aforementioned fixed-income ‘slowing growth’ concerns. A goldilocks interpretation of ‘easier financial conditions’ (weaker USD and lower US rates / flatter curves are a POSITIVE for large cap US corporates) against still-expansive data (yesterday’s US ADP print portending + for NFP) keeps stocks in a very ‘sweet spot,’ especially as the world is still awash in liquidity despite the ‘coming’ pivot tighter. To this point, EPFR data last night showed us that cash continues to be deployed in both equities (+$13.7B inflow in global Eq funds, a five week high absolute $ number) and bonds (+$6B inflow) as well. It seems like investors are appropriately taking their cues from very recent CB messaging: cautiously ‘slow and steady’ tightening in light of recently ‘softer’ inflation data.
Again, all of my conversations yesterday were centered around stocks and the ‘rotation’ being evidenced. Remember this from my note Wednesday?:
“Q1/Q2 ‘Mean Reversion’ strategy turning sloppy due to grinding move lower in rates, as ‘Value’ and ‘Size’ continue to fade against ongoing ‘Growth’ and ‘Anti-Beta’ U.S. equities leadership—nearing the inflection.”
“But everybody in the equities-universe it seems is aware of this dynamic, and fundamental folks are increasingly nervous about the potential for a reversal in mega ‘pain trade’ style—because it seems the entire world is ‘LONG TECH AGAINST SHORT ENERGY’…people are ready to pounce on this trade.”
--Me, Wednesday’s “RBC Big Picture”
When I wrote “HOW WE GOT HERE / WHERE WE’RE GOING” Wednesday, I certainly didn’t think that my key market / trading-takeaway—that being a pending and equities factor-rotation with significant portfolio positioning (and thus performance) impact—would commence within the following 24 hr period! Nevertheless, Thursday ‘happened,’ and ‘it was indeed quite the ‘pounce.’
This was classic “from worst to first” PM-grabbing into a new “FEAR OF MISSING OUT” stage of the equities-rally. For example, this year’s bottom three performing factor market neutral strategies which I track—‘Size,’ ‘Value’ and ‘Earnings Revision’--were the day’s three best-performing strats; and on the flipside, the YTD’s top four performing factor market neutral strategies—‘Anti-Beta,’ ‘Growth,’ ‘Momentum’ and ‘Quality’—were the days four worst-performing strategies.
‘WORST TO FIRST,’ AS WE SEE YTD FACTOR M/N LEADERSHIP ROTATE SHARPLY YESTERDAY:
This also was expressed in the form of many thematic and sub-sector dynamics reversing their YTD performance trends as well. For instance, five of the bottom six performing US equities themes or sub-sectors for Thursday’s session which I monitor--‘Nasdaq 100,’ ‘High Beta Tech,’ ‘Cloud Computing,’ ‘EM Levered Consumer Staples’ and ‘Semis & Semicaps’—are amongst the best-performing segments YTD by far, up anywhere from 17.2% to 30.4% YTD. It would be reasonable to assume that these sectors were being utilized as a ‘source of funds’ to move into those areas largely ‘left behind’ in 2017.
As such, we saw YTD laggards like ‘SMID Cap Consumer Staples,’ ‘Autos / Auto-related,’ ‘Food & Staples Retailing,’ ‘High Short Interest,’ ‘High Beta Industrials,’ ‘Russell 2000 Small Cap,’ ‘Low-End Consumer,’ ‘Media,’ ‘Domestic Consumer,’ ‘Food,’ ‘Airlines’, ‘Refiners & Integrateds,’ ‘Regional Banks,’ ‘Oil Services’ and ‘High-End Consumer’ as many of yesterday’s top performing subsectors. Mind you, that laundry list of spaces shows YTD performance from +4.0% to -24.9%.
SIGNALING THE ‘FOMO’ STAGE OF THE EQUITIES RALLY--REACHING INTO THE ‘STUFF THAT’S BEEN LEFT BEHIND’ (VIA YTD LEADERS AS ‘SOURCE-OF-FUNDS’) AS WE KICK-OFF A FRESH PNL MONTH:
Fact of the matter, this still wasn’t a completely SEISMIC shift (from an absolute-move perspective) and was obviously just ‘one day’—after all, the S&P Energy sector still muddled-along just +0.7% on the day (fourth-worst S&P sector on the day). BUT to my point in recent notes and as a sector-specific example, there are a lot of folks increasingly worried about missing a move in ‘energy’ too because it is a placeholder short / underweight, and will thus ‘hurt’ performance on the way back ‘up.’ As a random-sampling, by the first hour of Thursday’s session, the market had already seen XOP put spreads SOLD, while ECA, OAS, HAL and WLL all saw signif upside calls trade. Again, classic FOMO.
The larger story from a client-perspective was hyper-crowded ‘Technology’ as the S&P’s worst-performing sector as it inherently meant both hedge- and mutual- fund performance lagged index due to the sector’s enormous overweight. Tech underperforming on the day wasn’t ‘outright pain’ per se as it was still ‘up’…but obviously the buy-side is watching this very closely on the ‘follow-through’ because as noted earlier, it’s the natural ‘source of funds’ for ongoing rotation into laggard factors / sectors / themes. My guess though is that there is still too much ‘momentum’ here to see these winners outright ‘pitched’ aside yet…and ‘tech’ too will benefit from other sectors contributing to doing some of the heavy-lifting for the broad index on account of the sectors weighting.
The key question then: was this then a true rotation? Judging by the tape’s overall ‘burst’ higher (and follow-through globally overnight in both DM and EM), this clearly wasn’t any sort of ‘grossing down’ behavior (selling longs and covering shorts). So to me, this WAS opportunistic re-deployment of capital through ‘high flyer’ sources-of-funds into the beaten-down stuff that has clearly struggled in 2017. This is classic PM ‘reach’ behavior, looking for anything that hasn’t really participated in the CURRENT rally but is now set to participate in this potential NEXT leg.
I also continue to believe though that the key to SUSTAINING the move higher in YTD laggards (for example ‘cyclicals’ / ‘value’ / ‘small cap’) ultimately still requires a move higher in nominal rates / steeper curves. Obviously yesterday I made a case for a re-test or even break of the low-end of the ‘macro range trade’ coming first PRIOR to any potential bounce higher in rates. Equities do indeed have a knack of getting ‘ahead of’ the trade though, and that’s exactly what yesterday was: a fresh month of PNL and opportunistic PM behavior looking to juice returns by scooping losers. We saw this Wednesday too after I sent my note: our high touch equities desk flows showed energy as the 2nd most active sector overall and at 68% better to BUY, while tech flows were 70% for sale and almost entirely hedge fund driven.
I will continue to watch relative factor market-neutral strategy performance as an indicator of this ongoing ‘turn’—especially ‘value vs growth’ and ‘quality vs size.’
FWIW, yesterday’s decline in ‘quality m/n vs size m/n’ ratio was a two standard-deviation move, and the third largest since 1Q16’s mega market-neutral unwind.