SUMMARY: Yields dropped and equities gapped higher on the lower QRA release. Small caps outperformed and risk-on factors had positive l-s returns. We think the QRA is noise not signal but it was one market clearing event we needed to get through this week. What is left is a large slate of earnings (including MSFT and GOOG today, AAPL, AMZN, and META Thurs), JOLTS today, the Fed tomorrow, PMIs Thursday, and Payrolls Friday. It is a big week. Futures support our interpretation that this week is about clearing events. The implied volatility across SPX futures with different deltas expiring Friday skews to the downside (a smirk, chart on the left), and the drop off in implied vol after this week is significant (chart on the right).
Mega cap Tech is not Defensive explicitly but its returns to Size and Low Vol have become correlated. Yesterday Size and Low Vol were negative d/d. There has been an important shift in the exposure of Mega Tech to Growth. Two years ago, mega cap Tech was by far the highest Realized Growth group – growth rates of sales, cash flow, earnings. Today, Realized Growth exposure of the group has fallen. To be clear, these are still massively profitable companies. The point is that the amount of Realized Growth in other parts of the market has caught up. I.e., you don’t need to pay up for mega cap tech to get Growth.
S&P PE EX-MEGAS: We’ve been getting the most pushback on valuation. We are not making the call the index should move higher. Rather, mega caps should be a source of funds for the average stock. The index won’t move much higher under that scenario. The S&P NTM PE is 20, but ex the Mag 7 is 18. The spread between the S&P PE and the S&P ex-megas PE has been wide since COVID. We have been arguing that the economic regime has changed (HERE), and that the PE spread should reflect a more normal economic backdrop.
The valuation gap between small caps and the S&P 500 ex mag 7 is still stretched. Not as extreme, but still around its 25th percentile. If we get through this week without a significant increase in Vol or tightening in FCI, expect that to be somewhat of a clearing event for risk-on factors that have lagged (small caps, higher vol stocks, lower quality etc.).
More in the full report below…
MARKET VIEWS: The Treasury cut borrowing estimates – combo of Jan-March and April-June sums to $962B vs JPM estimates at $1,118B. Yields dropped, and equities rallied. Small caps outperformed and risk-on factors had positive l-s returns. We think the QRA is noise not signal but this is one market clearing event down on the week. Futures support our interpretation that this week is about clearing events. The implied volatility across SPX futures with different deltas expiring Friday skews to the downside (a smirk, chart on the left), and the drop off in implied vol after this week is significant (chart on the right).
Mega cap Tech is not Defensive explicitly but returns to Size and Low Vol have become correlated. Put simply, aggressive rotations into mega cap Tech coincide with large positive swings in Low Vol stocks, and vice versa. Yesterday Size and Low Vol were negative d/d.
There has been an important shift in the exposure of Mega Tech to Growth. Two years ago, mega cap Tech was high Realized Growth – growth rates of sales, cash flow, earnings. Today, the Realized Growth exposure of the group has fallen. To be clear, these are still massively profitable companies. The point is that the amount of Realized Growth in other parts of the market has caught up. I.e., you don’t need to pay up for mega cap tech to get Growth.
We’ve been getting the most pushback on valuation. We are not making the call the index should move higher. Rather, mega caps should be a source of funds for the average stock. The index won’t move higher in that scenario. The S&P NTM PE ex the Mag 7 is 18. The spread between the S&P PE and the S&P ex-megas PE has been wide since COVID. We have been arguing that the economic regime has changed, and the PE spread should reflect a more normal economic backdrop (HERE).
The valuation gap between small caps and the S&P 500 ex mag 7 is still stretched. Not as extreme, but still around its 25th percentile. If we get through this week without a significant increase in Vol or tightening in FCI, expect that to be somewhat of a clearing event for risk-on factors that have lagged (small caps, higher vol stocks, lower quality etc.).
