SUMMARY: The Fed announced Tapering at last week’s FOMC meeting but kept the funds rate unchanged, in line with the expectation but less hawkish than feared. The net result was a 15bp decline in the 10yr yield and a decline in the yield curve. Part of that decline was due to the dovish interpretation of Fed chair Powell’s press conference, and part can be explained by uncertainty about global growth (China in particular).
Factor performance also shifted following the Fed. Earnings Growth factors rebounded while Value, particularly Realized value, which had been performing well ahead of the meeting, declined. Value has been consistently underperforming Growth this year, even as Cyclical sectors have persistently gained relative to Defensives.
In the post-GFC period, changes in the 10yr yield have been most positively correlated to Realized Value and Liquidity factors returns. Realized Growth and Low Volatility are the most negatively correlated with changes in the 10yr yield. The 2021 Summer to Fall rebound in 10yr yields did not lead to the Value outperformance that those historical correlations would suggest.
Longer term, with growth firm and inflation expected to drift lower but remain above GFC levels, bond yields are biased higher. Nearer term, the macro backdrop favors a range bound 10yr yield, reducing its influence on factors returns and removing a potential tailwind to a Value rebound. Low Volatility names stand to benefit though from a flattening of the yield curve. We present a list of Low Volatility Cyclicals at the end of this report.
Tantrums, Yields & Factors: The Fed announced Tapering at last week’s FOMC meeting but kept the funds rate unchanged, in line with the expectation but less hawkish than feared. The U.S. 10yr yield dropped 15bp and the short end of the curve declined as well. Part of that decline was due to the dovish interpretation of Fed chair Powell’s press conference, and part can be explained by uncertainty about global growth (China in particular). Inflation expectations remained stable. Factor performance also shifted following the Fed. Earnings Growth factors rebounded while Value, particularly Realized value, which had been performing well ahead of the meeting, declined.
In the post-GFC period, changes in the 10yr yield have been most positively correlated to Realized Value and Liquidity factors returns. Realized Growth and Low Volatility are the most negatively correlated with changes in the 10yr yield. Today’s macro backdrop favors a range bound 10yr yield, reducing its influence on factors returns and removing a potential tailwind to a Value rebound.
Interestingly, during the late-2013 Fed tapering, which saw bond yield spike higher before collapsing back in early 2014, Momentum and Growth outperformed while Value and Low Volatility underperformed. The taper tantrum led to concerns about premature policy tightening and slower economic growth. So far, the Fed has done a good job this cycle in separating tapering from rate hikes, potentially heading off the kid of Growth rally seen during the 2013 cycle.
The level of yields is different toady and implied real rates remain near their lowest level on record. As with 2013 though, there is downward pressure on U.S. 10yr yields and yield curve near term. That backdrop is more likely to support Momentum and Growth than Value names.
Recently, Low Volatility factor underperformance has been more related to the underperformance of Defensives. Today Defensives are most exposed to Low Volatility and they have been more Low Volatility exposed since the start of this year. Energy, the best performing sector this year, however, has the lowest exposure to Low Volatility.
Cyclicals continue to outperform even as Growth has gained, and even a broad Low Volatility rotation is not likely to support Defensives into year-end unless there are significant negative revisions to the growth outlook.
Below we offer up a list of Cyclical names with the highest Low Volatility rankings. These are names well positioned for a depressed yield backdrop where the growth outlook remains stable.
