STRATEGY: PEAK “growth scare” and now expect interest rates to push higher
As many of our clients know, we have had three central views heading into July 2021 that caused us to be cautious. The three factors:
– first, the “delta variant” of COVID-19 we thought could trigger a parabolic rise in US cases possibly towards 100,000
– second, strong 1H2021 = weak July (see multiple prior notes). Consensus expected strong seasonal July
– third, we viewed interest rates as “undershooting” consensus
These collectively gave us the sense that the month would be overall marked by “chop” and worse than the positive seasonals many cited. So far, this first week has proven to be vicious and terrible. However, we think today marks a key turning point. Specifically:
– today marks “peak growth scare” in our view
– therefore, US interest rates are expected to be pushing higher
– this is a BIG REVERSAL of our view, which was previously expecting rates to “undershoot”
– in other words, we think next 50bp of interest rate move is now higher
– EXTRA CREDIT: we think VIX possibly making its July peak today = risk-on
…today is peak fear = buy this dip especially in Epicenter
In terms of strategy, this is a very positive development. As you know, it has been concerning to see the US 10-yr drift steadily lower, even as the contemporaneous incoming economic data has been strong. This divergence needed to “true up” and with falling rates, this was increasingly the risk of downdraft in stocks.
– but for multiple reasons, we think today might mark that turning point and now cyclicals, in particular, might be poised to rally hard.
3 factors drive interest change vs consensus…
We don’t explicitly forecast interest rates. However, logically, there are 3 components (of interest rate change) influencing future rate changes for the US 10-year:
– GDP growth expectations –> if lower vs consensus –> rates downside
– Inflation expectations –> if lower vs consensus –> rates lower
– Interest rate “risk premia” (aka vol) –> if risk lower vs consensus –> rates downside
For the past few months, we have highlighted the fact that these factors were likely to cause the 10-year to undershoot. This was the rationale for our downgrade of Financials on June 10th. And commensurately, our “double upgrade” of FAANG on June 10th. Basically, bet on FAANG if rates would undershoot.
…we now think actual direction of interest rates “overshoots” consensus
We now think the next 50bp of interest rate change is higher. As explain below, going forward, the 3 components (of interest rate change) are:
– Growth expectations –> flat vs consensus –> Fundstrat now sees “higher”
– Inflation expectations –> flat vs consensus –> Fundstrat now sees “flat”
– Interest rate “risk premia” (aka vol) –> flat vs consensus –> FOMC took away “risk” by eliminating tail events
As you can see, we don’t see the “soft factors” pushing interest rates lower. Thus, we think the next move is higher in the US 10-year.
TIMING: “vicinity of bottom” in US 10-year rates could happen within the next 5 trading days
We think US interest rates are within the vicinity of a bottom. The tactical picture still seems to suggest some downside. But a simple rule of thumb is below:
– US 10-yr 200-day moving average is 1.2538%
– US 10-yr today “kissed” that figure today
This is a level to watch. We think the 10-yr yields will bounce higher from here. The rationale is explained above. But in short, we are past peak “growth scare.”
This headline is what also makes me think we are at peak “growth scare” as not surprisingly, the Tokyo Olympics will ban spectators on the heels of the spread of the “delta variant”
Source: https://www.cnbc.com/2021/07/08/japan-olympics-committee-bans-spectators-following-state-of-emergency.html
BOTTOM LINE: If interest rates REVERSE, BUY Epicenter which is gonna rally MOST
July is shaping up to be a choppy month. But going forward, we see strong 2H gains. Given the shift in our interest rate view, we now think this leads to a rally in the Epicenter stocks. As below shows:
– US 10-yr interest level leads Epicenter stocks
– Price ratio: Epicenter / NASDAQ (SPHB/QQQ)
MEANING: higher 10-yr = surge in Epicenter
Is this too simple? Maybe. But it surely seems to be at work since the pandemic started. We would be aggressively buying Epicenter here. We realize the 10-yr might not bottom for 5-10 days. But this is tactically the time to be leaning into view of higher rates = buy Epicenter
BOTTOM LINE: Still see July “chop” + strong 2H2021 + Epicenter strong
Thus, leadership from this rally is both Epicenter and FAANG:
– Energy remains our favorite sector, given the positive supply/demand dynamics in oil
– FAANG benefits from the “undershoot” of interest rates, relative to consensus
– we also like Epicenter stocks broadly, and the incoming data this week should be supportive
– But July has complex and conflicting headwinds
ADDENDUM: We are attaching the stock lists for our 3 portfolios:
We get several requests to give the updated list for our stock portfolios. We are including the links here:
– Granny Shots –> core stocks, based on 6 thematic/tactical portfolios
– Trifecta epicenter –> based on the convergence of Quant (tireless Ken), Rauscher (Global strategy), Technicals
– Violence in USA –> companies that are involved in some aspect of home or personal security. We are not “recommending” these stocks, but rather, bringing these stocks to your attention.
Granny Shots:
Full stock list here –> Click here
Trifecta Epicenter (*):
Full stock list here –> Click here
Power Epicenter Trifecta 35 (*):
Full stock list here –> Click here
Violence in USA:
Full stock list here –> Click here
(*) Please note that the stocks rated OW on this list meet the requirements of our investment theme as of the publication date. We do not monitor this list day by day. A stock taken off this list means it no longer meets our investment criteria, but not necessarily that it is neutral rated or should be sold. Please consult your financial advisor to discuss your risk tolerance and other factors that characterize your unique investment profile.