By Peter Tchir of Academy Securities
Who’s more famous to the billion millions?
It seems like it has hit a point where it is impossible to avoid discussing the Magnificent Seven. However, at least I can write it with the Clash playing in the background.
I continue to believe in my very simple theme. After the July meeting (where the market has already given the Fed the green light to hike 25 bps):
The Fed (unless they do something new with their balance sheet reduction program) should largely be “a non-event” for the rest of this year. Yes, occasionally markets will move as the Fed messaging (or jawboning) changes tone, but unless the data comes in decidedly bad or good for an extended period of time (2 or more months), they are going to try to be on hold.
The volatility being priced into the bond market seems too high relative to equities
Traditionally, the two move in the same direction in somewhat similar orders of magnitude. Since the Fed started their hiking cycle, bond market implied volatility has been much higher than stock market volatility. While part of this is because the depth of true liquidity in the bond market is lower (relative to its size) than the liquidity in the equity market, bond market volatility should eventually decline (or “normalize”) relative to equity volatility.
I expect 2s vs 10s to become less inverted as the two-year can start pricing in a lower Fed Funds rate a year or so out. However, 10s can start to price in a higher terminal rate and a longer timeframe to get there.
Ring! Ring! It’s 7 a.m. (ok, I couldn’t resist another line from the song).
We have seen a divergence between the major indices and their equal weighted siblings (and it has been quite extreme this year). For example, the Nasdaq 100 has a YTD return of 43% compared to an equal weighted return of 24%. The S&P 500’s YTD return is 18% vs. 8% for the equal weighted version.
Regarding the S&P, while the equal weight is “only” lagging by 10% this year, that divergence is bigger than what we have seen historically. With 500 names, it is more difficult for any one stock (or seven stocks) to drive the index returns, yet a handful of stocks have really driven this divergence. What strikes me as “curious” is that it looks like there was a clear “start date” to this trend in the S&P 500. Until March 9th, the S&P 500 and the equal weighted version marched along (more or less) in tandem. Since then, the divergence grew and has remained quite high!
If there is any “consolation” for those mired in the Russell 2000, both the equal weighted and regular weighted indices have lagged the broader market (Russell is up less than 10% YTD). Historically, you would expect that the Russell 2000 would do well when the other major indices are doing well, because it should be about the economy or liquidity. However, the Russell 2000 is struggling to get out of its own way this year. And yes, if there were problems in the high yield bond market (or even the leveraged loan market), I’d expect that to weigh on the Russell 2000, but those markets have both been healthy this year. Yes, there are some concerns (especially about some segments of the leveraged loan market), but as a whole those markets are behaving well, which should support the Russell 2000.
Some of the blame can be attributed to the regional banks (KBW Regional Bank Index is down 20% YTD). But is that really enough? Does that explain this divergence? I don’t think so.
I haven’t mentioned ARKK (a “disruptive tech” ETF) in a long time and it is “only” up 55% YTD. Yes, 55% is a great return, but if you told me that the Nasdaq 100 would be up 43% this year, I would have bet (based on its high beta) that ARKK would be up much more than 55%.
Again, this highlights just how specific the themes/trends have been this year.
On this rainy Sunday morning, I am thinking about barbecue. More specifically, I’m thinking of those Brazilian steakhouses (no offense if they aren’t really authentic) where you get a disk with green on one side (you want more meat brought to you) and red on the other (indicating, at least for a moment, that you need a breather).
It almost looks as though on March 9th, someone turned their disk to green and has been gorging ever since.
The questions are:
What I want to believe:
What I’m starting to believe:
Well, this basically leaves me with a good song and some steak on my mind.
Two final thoughts (mostly related to equities):
I am really looking forward to earnings because they will provide the best insights into how sustainable the current valuations are and whether we could see a pop in the laggards!