FADING MOMENTUM IS HARD: We are near the top of our S&P 500 fair value range (3800 – 4200) and Momentum has been the best performing factor since early Feb. In a mean reverting backdrop, that implies it’s a good time to think about fading momentum. Since Jan 2022, our Price Momentum factor has fallen aggressively whenever it has fallen, but there isn’t any consistent timing. The price failure factor, which is a l-s basket playing reversals of short term (1wk – 1mo) price momentum, has performed poorly for much of the past year. Momentum factors were among the most volatile factors last year. There is risk and a lot of volatility to playing a Momentum reversal without a catalyst.
Through options trades, high volatility means S&P puts are expensive. Recently, 1-month, 25 delta SPX puts have come down in price, but are still elevated relative to 2021 (and certainly elevated relative to pre-pandemic). With vol expensive and catalysts mixed (we think earnings will be better than expected, but the Fed more aggressive than expected), we prefer positioning for reversals in industry groups/single stocks we have conviction in.
That matches up with one of our highest conviction themes – positioning for less intra-portfolio correlation. As near-term recession risk eases, there should be more internal dispersion than movements at the index level. Earnings season ought to present opportunities as well. Stock picking remains a better path to outperformance than market timing. That is one of the motivations behind yesterday’s NVDA trade. John Roque continues to believe NVDA is going to weaken, so with his help, we structured a NVDA trade (details HERE).
One way to play dispersion through indices is pairing RSP (Invesco S&P 500 Equal Weight ETF) vs SPY. We recommended that trade a couple weeks ago (HERE). To recap, we like buying RSP risk reversals and SPY collars, expiring in June. Since then, skew shows investors have not embraced equal weight vs cap weight more. Skew in the SPY is stable, while skew in the RSP has shifted a little more bearish. We still like the trade here.
PAIN TRADE: BofA’s latest fund managers survey found investors are the longest bonds relative to stocks since 2009. As we highlighted in today’s DN (HERE), we think yields are biased higher from a combo of 1) sticky inflation/decent growth 2) a persistent Fed, and 3) a likely higher neutral rate (HERE). Long bonds (short yields) relies on elevated near-term deep recession risk, which we do not think is a given. Our macro quant model classifies the current regime as ‘Transition,’ but the probability of ‘Normal’ has risen in recent months, despite investors’ perceived odds of a recession rising. There is a growing disconnect between recession expectations and the distribution of economic data.
The pain trade is higher yields and higher equities. To hedge against that risk, which is cheap given positioning, we like buying SPY 6/16 $432 calls and selling TLT 6/16 $111 calls (TLT price moves opposite yields). The trade could also be structured by selling SPY and TLT puts, but given the SPY is at the top of our fair value range, we prefer buying SPY calls. We have more conviction on rates. Some scenarios mocked up below.
ELS RECAP: The performance of all our equity linked strategies is below. We would close the short Transports trade. Although we still prefer Early Cyclicals, Transports have mean reverted and the trade has worked. We would also close the Real Estate vs Health Care trade from earlier this year. We are staying away from REITs while there is growing concern over commercial real estate.
Many of our open trades have been disrupted by the bank failures. Retail vs Staples was particularly poor (and would’ve been stopped out). But since bank systemic risk is fading, that means there are market dislocations that could close, like Retail vs Staples.
