GDP readings have been stronger than expected and estimates for 2024 real GDP growth are up to 1.5%. That is consistent with the improvement in our Macro Regime Model, which rotated into a Growth phase last December. At the end of January, the model’s odds of being in a Growth regime have increased further. Historically, rotations into Growth coincide with improving NTM GDP growth expectations, and an increased emphasis on Style factors.
Of all the macro factors impacting the regime classification, yields, and the yield curve are the most influential. Yield volatility has been declining, which has helped support the improvement of the regime. Scenario analysis – where we change one model input and leave all others fixed – shows the ranges of yield and yield curve moves needed to maintain a Growth regime classification are narrow.
If a larger number of cuts were priced in, or a meaningful (~-40bps) reinversion of the curve, the model COULD (other inputs would have to remain steady) shift back to Transition. That is not a call but helps explain the risk-off move earlier in the month when investors were worried about growth surprising to the downside AND cuts being priced out. The 10yr – 3mo yield curve is deeply inverted and a soft landing is increasingly seen as the economic base case. That suggests more steepening ahead, which would be a support for a continuation of the current regime.
We introduced factor sensitivity analysis in our latest Quant report (HERE), which measures the isolated factor impact on the stock total returns (alpha + beta). Breaking down historical S&P factor sensitivities by different regimes shows Realized Value has a negative sensitivity in Normal regimes and is nearly the highest in Growth periods. Overall, expansion periods lead to higher sensitivities for both Realized Growth and Realized Value while Risk factor sensitivities tend to decline. This is another reason why a focus on style factors is important in the current regime. We continue to favor GARP names given the uncertainty around the growth/policy path near-term.
High Impact from Yields on the Macro Regime: GDP readings have been stronger than expected and estimates for 2024 real GDP growth are up to 1.5%. Inflation, labor market, and retail sales readings into this year have all been strong as well. That has been aligned with our 22V Macro Regime Model rotating into a Growth phase last December. At the end of January, the model’s odds of being in a Growth regime have increased (the model is probabilistic and odds of Growth are now ~98%). As we discussed (HERE), historically, rotations into Growth coincide with improving NTM GDP growth expectations. That is playing out now as well.
Of all the macro factors impacting the regime classification, yields, and the yield curve are the most influential. Yield volatility has been declining, which has helped support the improvement of the regime. Assuming some rate cuts this year, short rates will trend lower re-steepening the yield curve and providing support for the current regime reading.
Scenario analysis – where we change one model input and leave all others fixed – shows the ranges of yield and yield curve moves needed to maintain a Growth regime classification is narrow. In other words, a sharp steepening of the curve, which is most likely if a larger number of cuts were priced in, or a meaningful (~-40bps) reinversion of the curve, could shift the model back to Transition. That is not a call but helps explain the risk-off move earlier in the month when investors were worried about growth surprising to the downside AND cuts being priced out. Market based estimates for a Fed rate cut in March now is around 45%, but the FOMC meeting today could change that probability and the assumed rate path.
Currently, the 10yr -3mo yield curve is deeply inverted (1%th percentile historically), and near the lowest point in ~40 years. Recession odds are still very low 15 months after the first curve inversion. Curves should rebound from here as a soft landing is increasingly the base case, supported by expanding macro growth and expected Fed rate cuts.
Breaking down the components of our regime model, both aggregated macro and market conditions are moving toward Growth, but market conditions are doing the heavy lifting. Aggregated macro conditions have slipped some over the past year as inflation eased. Market conditions, on the other hand, have improved and climbed higher. To be clear, a market decline alone would not put the model into a Transition/Recession regime. The Macro vector of the model is far from where recessions tend to occur. Material market weakness remains a reason to add to risk UNLESS macro trends deteriorate.
We introduced factor sensitivity analysis in our latest Quant report (HERE), which measures the isolated factor impact on the stock total returns (alpha + beta). Breaking down historical S&P factor sensitivities by different regimes shows that most factors’ sensitivities are directionally the same between Growth and Normal regimes. There is one significant standout though – Realized Value has a negative sensitivity in Normal regimes and is nearly the highest in Growth periods. Overall, expansion periods lead to higher sensitivities for both Realized Growth and Realized Value. Risk factor sensitivities tend to decline. This is another reason why a focus on style factors is important in the current regime. We continue to favor GARP names given the uncertainty around the growth/policy path near-term.
