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STRATEGY: PEAK "growth scare" and now expect interest rates to push higher
Stocks have endured a tough few days which is not evident looking at indices. There has been a breadth deterioration and most easily seen by realizing only a few sectors are still in uptrends.
- Energy
- FAANG
- Technology
Everything else looks to be in a consolidation and/or downtrend. These few groups are really supporting the market.
And our central case has been for a choppy July with a possible selloff to S&P 500 falling to 4,100. While this is a possibility, we think there is a chance Thursday marked the peak of “growth scare” and if this is correct, equities might be shifting towards a broader risk on.
We sent out an INTRADAY WORD about the most important reversals we are watching possible:
- bottoming of US 10-year at 1.25%, touching 200D
- VIX not mustering much upside oompf and making lower highs = risk-on
Thus, if these two conditions are correct, it would be appropriate to expect some major shifts in sector leadership. Specifically:
- S&P 500 might not fall to 4,100 as this might just be another rolling correction
- US 10-year will start drifting higher, possibly back to 1.75%
- Epicenter stocks will rally strongly, as they are the most sensitive to rising rates
Take a look at this chart below. It’s the US 10-yr yield and price ratio Epicenter/ Nasdaq 100.
- since 10-year started falling
- Epicenter lagging badly
- Is this too simple? Maybe
I realize this could be early to make this call. And our conviction is 60%. But this is a reversal of our views on the market. So directionally it’s a big change.
…where are we wrong? Two things we are watching
The natural question is where will we be wrong?
- if US 10-year falls below 200D (1.25%), we reassess
- If VIX surges past prior high (22) we reassess
The technical picture per demark is not really decisive on rates or Vix. So we are in “no man’s land” from a technical perspective. This is what keeps our conviction lower. By the way, see our INTRADAY WORD for the rationale behind our change in interest rate views.
BACKGROUND: 3 factors drive interest change vs consensus...
We don't explicitly forecast interest rates. However, logically, there are the 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 the rationale for our downgrade of Financials on June 11th. And commensurately, our "double upgrade" of FAANG on June 11th. Basically, bet on FAANG if rates would undershoot.
BACKGROUND: we now think actual direction of interest rates "overshoots" consensus
We now think the next 50bp of interest rate change is higher. As explained below, going forward 3 components (of interest rate change):
- Growth expectations --> flat vs consensus --> FSInsight now sees "higher"
- Inflation expectations --> flat vs consensus --> FSInsight 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.
Similarly, a VIX above 22 would be a "higher high" -- the VIX has been in a pronounced downtrend since October 2020 and as shown there have been successfully lower "highs"
- the last local high was 22
- if the VIX cannot muster a move above 22, then we think VIX is headed lower
= risk-on
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