Financial conditions are tightening ahead of the Jackson Hole meeting this week. Investors are discounting what is broadly expected to be a hawkish speech by Fed Chair Powell. Yields are climbing while equity market PEs fall, oil prices move higher, and implied volatility increases. High volatility and lower quality Tech names performed VERY well during the recent rally, but those gains have started to reverse as financial conditions retighten. ARKK dropped again since the recent high last week and has lost -16.9%. Tighter financial conditions, slower growth, and increased recession risk is a bad backdrop for speculative Tech.
As we discussed earlier (details here), volatility has been the major driver of financial condition spikes this year. Gains in the VIX and MOVE have contributed to recent tightening, but the spread between MOVE and VIX remains wide (83rd %tile). Increasing recession risk suggests the spread will be closed by the VIX moving higher. Defensive names benefit from rising volatility and tightening financial conditions. Within Tech, Tech Hardware is currently most positively correlated with volatility changes and should benefit from further gains in the VIX, at the expense of Software and Semis.
Factor performance within Tech as financial conditions tightened this year has been volatile. Low Volatility gained in all periods, suggesting a tilt toward lower Vol Tech – mega caps over smaller more speculative names – continues to make sense. Momentum, Earnings Growth, Liquidity, and Quality of Earnings are more negatively impacted by the tightening of financial conditions and have generated consistent declines this year.
After the volatility spread between stocks and bonds has narrowed, a more gradual tightening of conditions and slowing of growth would benefit Software. Software also has the highest Low Vol exposure of any Tech industry, which should be a support relative to Semis.
We list the S&P 1500 Tech names falling into top quintile Low Volatility basket. These names should benefit in tightening financial conditions backdrop. And the names with high Liquidity exposure are more likely to face downward pressure.
Tech Positioning as Financial Conditions Tightened: Financial conditions are tightening ahead of the Jackson Hole meeting this week. Investors are discounting what is broadly expected to be a hawkish speech by Fed Chair Powell. Yields are climbing while equity market PEs fall, oil prices move higher, and implied volatility increases. Tech names, which are negatively correlated with volatility in general, have been facing more downward pressure as well. After reaching a post-GFC high back in January, the put call spread of Mega Tech names, which are highly exposed to Growth and Quality of Earnings, has moved to extreme levels. Put volume has increased recently, but investors are still positioned for the rebound in Mega Cap Tech.
High volatility and lower quality Tech names performed VERY well during the recent rally, but those gains have started to reverse as financial conditions retighten. ARKK dropped again since the recent high last week and has lost -16.9%. Meme stocks have followed a similar trend, but are only down -3%. Tighter financial conditions, slower growth, and increased recession risk is a bad backdrop for speculative Tech.
Volatility has spiked into this week ahead of Jackson Hole. As we discussed earlier (details here), volatility has been the major driver of financial condition spikes this year. Gains in the VIX and MOVE have contributed to recent tightening, but the spread between MOVE and VIX remains wide (83rd %tile). Increasing recession risk suggest that spread will be closed by the VIX moving higher. Over the past year, financial condition have seen intense shifts around Fed meetings and important Fed speeches.
Defensive names benefit from rising volatility and tightening financial conditions. Within Tech, Tech Hardware is currently most positively correlated with volatility changes and should benefited from further gains in the VIX, at the expense of Software and Semis. That trend has largely played out over the past week. Longer-term tightening of financial conditions, brought on by widening spreads, tighter money market conditions, etc., should be a tailwind for Software given their positive correlation since 2010.
Currently, Tech industry groups are all highly exposed to Realized Growth and Quality of Earnings at the expense of Realized Value and Earnings Turbulence. Software is also positively exposed to Low Volatility, which helps explain the tailwind from tightening financial conditions. Hardware’s high-Quality scores should be a support as long as recession uncertainty remains high, but the factors has not performed well so far this year.
Factor performances within Tech during tightening of financial condition this year has been volatile. Low Volatility gained in all periods, suggesting a tilt toward lower Vol Tech – mega caps over smaller more speculative names – continues to make sense. Momentum of Price, Earnings Growth, Liquidity, and Quality of Earnings are more negatively impacted by tightening of financial conditions and have generated consistent declines this year.
While most of Tech tends to have higher volatility, below we list S&P Tech names in the S&P 1500 that fall into the top quintile Low Volatility basket. Tightening of financial conditions brings the strongest, most consistent tailwind to Low Volatility names.
The short list below are S&P 1500 Tech names falling in the high Liquidity basket that should face more headwinds during the tightening of financial condition.
