SUMMARY: Despite volatile debt ceiling headlines and growing concerns over the TGA drawdown removing liquidity from the market, Earnings Turbulence is recovering relative to Low Vol. Another round of mean reversion is working right now, and we think that will continue. As we noted in our Weekly report (HERE) and a Daily Note (HERE) earlier this week, mean reversion favors Deep Cyclicals (Energy, Industrials, Materials) over Early Cyclicals (Tech, Discretionary, Communications) and is a negative for large-cap Tech in particular. Again, longer term we favor Early Cyclicals as inflation and economic growth slow, but mean reversion has been consistent, and lower near-term recession fears provide relief for Deep Cyclicals for a few weeks or a month.
The recent rally in regional Banks is helping Earnings Turbulence (ET) performance overall, but ET is also working as a screening tool across most industry groups. Interestingly, TMT industry groups are some of the few bucking the trend, and as the Quant team noted this week (HERE), the group tends to exhibit mean reverting characteristics. We expect Tech to fade short-term.
HOMEBUILDER PULLBACK: Homebuilders have outperformed the S&P 1500 by 16% YTD, outpacing both hard and soft housing data. Price action has run ahead of the anticipated improvement in housing activity. A Fed pause removes an important headwind to residential investment though and we wouldn’t push back against that.
The spread between data and performance is in its 99th percentile though. And household affordability is still at its 2nd percentile. Homebuilders are most exposed to EPS momentum, Momentum of Price, and Realized Growth, leaving it susceptible to mean reversion (HERE), a trend we see starting now.
John Roque agrees, noting “It should not surprise us to figure that a correction should unfold for this Index/homebuilding stocks given the overbought readings (daily version has been softening for two weeks) plus the recent upward jaunt for yields.”
Details in the full report below…
MARKET VIEWS: Despite volatile debt ceiling headlines and growing concern over the TGA drawdown removing liquidity from the market, Earnings Turbulence is recovering relative to Low Vol. Avoiding a default is well within consensus (HERE), and negative headlines are having a larger effect on short-term Treasury Bills than equity internals. Mean reversion is working right now and we think it will continue as acute nearby recession fears following SVB’s failure are unwound.
The recent rally in regional Banks is helping Earnings Turbulence performance overall, but ET is also working as a screening tool across most industry groups. Interestingly, TMT industry groups are some of the few bucking the trend, and as the Quant team noted this week (HERE), they tend to exhibit mean reverting characteristics. We expect Tech to fade short-term.
HOMEBUILDER PULLBACK: Homebuilders have outperformed the S&P 1500 by 16% YTD, outpacing hard and soft housing data. Price action has run ahead of the anticipated improvement in housing activity. A Fed pause removes an important headwind to residential investment. We wouldn’t push back against that. Last week, Gerard talked about how the drag from single-family housing is set to fade (details HERE). And demographic trends are favorable for the group.
The spread between data and performance is in its 99th percentile though. And household affordability is still at its 2nd percentile, thanks to increases in median home prices and mortgage rates. The drag from housing activity is set to fade, but affordability likely needs to improve for another burst of activity. That’s ultimately dependent on a soft-landing unfolding, which would reduce the 90th%tile+ spread between mortgage rates and the 10yr yield.
Homebuilders are also most exposed to EPS momentum, Momentum of Price, and Realized Growth. These factors are susceptible to the most recent mean reversion (HERE) trend, which has started and we expect to see continue.
Price to book for homebuilders had been unusually low and is now back to its median. Valuations for the group aren’t a headwind, but the tailwind from the equities being “cheap” is gone. We think Homebuilders are susceptible to a short-term correction. The longer-term outlook isn’t bad, but there looks to be some price dislocation short-term.
John Roque notes “From Oct 21, 2022 – May 19, 2023 (144 days or just about 29 weeks) the S&P Homebuilding Index gained almost 70% which produced daily and weekly overbought readings. It should not surprise us to figure that a correction should unfold for this Index / homebuilding stocks given the overbought readings (daily version has been softening for two weeks) plus the recent upward jaunt for yields.”
