April 12

High Noon

high noonBy David Nelson, CFA & CMT

Chasing stock returns has always been a national pass time. In the last six months if it wasn’t popular meme stocks and SPACs it was the latest IPO or ETFs following the next hot asset class. Staying in front of the crowd is no easy task as some trends lasted only weeks and others just days.

One of the most talked about trends of late had been the outperformance of Small Cap ETFs like (IWM) outpacing its large cap brothers and sisters for the last 6 months. In response to an economy coming out of a pandemic coma and the prospect of millions being vaccinated it made sense to shift some funds from large cap secular growth.

Analysts across the spectrum including yours truly embraced this long-ignored asset class. Relative valuation, upside estimate revisions and less dependence on an overvalued technology sector were all taking points in the print and broadcast media.

Turn it Upside Down

The last two weeks have taken the above scenario and turned it upside down. Large Cap Secular growth including popular FAANG favorites like Amazon (AMZN) and Facebook (FB) have been leading stocks this month. Even sector relative performance charts are upside down vs the first 3 months of 2021.

As I pointed out in last week’s article most investors are overweight growth even if all you own is the S&P 500. However, the above begs the question why the sudden change of heart on small caps and more cyclical shares especially if the economic scenario, I laid out above is on our doorstep.

Rates rose faster than stocks

Rising right along with small and mid-cap stocks were yields driven by the prospects for increased economic activity and inevitable inflation. 10-year yields have more than tripled from 50 basis points to a closing year to date high of 1.74%. The above all makes sense especially in the context of coming GDP prints likely the highest in decades and rising inflation expectations. Friday’s Producer Price Index came in at 1.0% double what analysts were expecting.

In the end, sector and asset class performance will all come down to rates and the ability of the Fed to control the yield curve. If you don’t think rates are a big part of the picture look at the chart above showing the relative performance of Growth vs Value in the context of flat to falling yields for most of the last decade. The blow off top for Growth came as yields cratered to all-time lows during the pandemic last year. Large cap secular growth is often referred to as long-duration equity as investors embrace its steady cash flows as a substitute for low yielding fixed income.

10-year yields have recovered to pre-pandemic levels but as of late have stalled out looking for the next catalyst. One would have thought that a monster PPI well above expectations would have been enough to push them higher but Friday saw rates all across the curve end the day in the red.

March PPI

Goldman came out with a note last week saying, “don’t fight the Fed.” Hardly a new concept but given Powell has implied they will use every tool in their quiver to hold rates steady and keep monetary conditions loose we may have to take him at his word. Fighting the Fed has not been profitable for most of the last 12 years.

High Noon

For the moment it looks like High Noon with Sheriff Jay Powell on one side of the street and Inflation Data on the other. Powell is determined to bring employment and the economy back to pre-crisis levels. If rates continue to hold at these levels or drift higher with little momentum markets may give him the time, he needs to finish the job. If not…

*At the time of this article some funds managed by David were long IWM, MDY, RSP and SPY