Forgive the longer missive this morning but we’ve finally seen some cross asset flows beyond just buy US equities and a wider lens is worth articulating. With one week left in February, it’s worth reflecting on the market moves since the November election and year-to-date. The equity ascent post Covid really started once the Fed introduced ‘unlimited’ to the monetary toolkit but it’s the fiscal actions that really helped fuel the S&P 500’s 20% rise since the November election and 500 bps rise year to date.
Regardless of past performance, the past two to four weeks are showing signs the market response is broadening from just US equities. Economic data really can’t get much better and now Europe is kicking in. And the reality is there’s still massive pent up demand as economies reopen socially. Although yields upticked of late, the move (until this week) was almost entirely focused on the long end through a steepener while currencies remain fairly contained. Moreover, commodity strength (more or less) has been isolated to Copper and Crude.
Looking forward, the risk takers I talk to expect some material portfolio reallocation given the year to date move in bonds and stocks. But the surge in economic data amid vaccinations and openings would suggest the possibility of 10% further upside in broader equity indices through April earnings season. Though Copper and Crude have had material runs, they too could see 10-20% rises from current levels through year end. Ten Year treasuries reached a level that may have triggered some leverage adjustment but economic data would now suggest there’s much more to ‘price’ in for fixed income.
For now, Powell isn’t thinking about “thinking” about monetary adjustments. At this point, the market will likely tell him when it’s time to think about it and by the time they finally act, we may well be closer to the terminal rate. I don’t know where the “terminal” rate is but if we’re going to pump until inflation runs hot, it must be in the 250-300 bps range).
Strategy and Levels
Near term we may be in store for a fixed rally / equity sell off reallocation post options expiration due to month-end rebalancing. Any move in that direction should be used to factor the possibility of 2-5% downside in SP but 5-10% upside remaining into April earnings season. The curve should bear flatten (long end sells off but shorter duration sells off relatively more as market anticipates the fed hiking) as ’13 Eurodollars and Five Years begin to at least create something for Powell to ‘think about’.
Despite this week’s move, Eurodollars in the latter half of ’13 and early ’14 alongside Five Years seem ‘low’ for 12 months with stops above the year’s high. I’ve been shocked at the lack of participation from Europe and UK equities and they struggle when the currency appreciates but ‘value’ still seems to exist in Russell, Banks, FTSE, and European banks (to some degree).
The Nasdaq is more than just growth names but I believe they will ultimately struggle (relative to the field) as rates rise in the short end. Copper and Crude are extended but 21-34% pullbacks of the move from November and January runoff election(s) are places risk takers I talk to are looking to buy. FX remains the most difficult asset class but commodity currencies almost have to participate at some point.
If you try to rank developed markets for those that ‘might’ be first to move on monetary policy, all roads generally go back to Kiwi and Aussie. Swiss and Yen ‘should’ remain liabilities and dollar positions and views ‘overall’ are likely too bearish for the nominal interest rate differentials at current.
This hasn’t been easy unless you were just long US equities. But the past few weeks injected some cross asset flows based on real economic data. The short term reactions across markets were harder to gauge but we ‘should’ be able to step back and recognize this is the first phase of markets adjusting to a gradual rise in yields.
Macro & Event-Trading Specialist