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22V Swaps – Performance Recap Into and Out of CPI

Published on February 14, 2024

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By

Dennis DeBusschere

Brian Herlihy

Kevin Brocks

Sophia Wang

Heading into CPI, risk factors (MS22RISK Index), companies with debt problems (MS22DEBT Index), and SMID GARP (MS22GARP Index) were all rallying, tentatively. The hot CPI reading yesterday led to a dramatic reversal in yields and in these swaps. Today, some of that reversal is fading.

We are not changing our call for risk-on factors and Cyclicals to outperform over the course of 2024. Over time we think it will become clear that January was more one-off vs a new CPI trend, though that needs to be proven first before risk on factors, SMID and Cyclical assets can gain a bid. If you don’t believe us, buy risk-off (MS22VOL Index) and Quality vs Debt (MS22LQSD Index).

Risk factors (MS22RISK Index) were up the week into CPI, but have now continued the downward trend seen for most of this year. Mega cap profitability has been a strong tailwind to larger, low vol equities while hot data continues to weigh on riskier assets. If CPI proves to be a one-off and data returns to trend, risk assets can catch a bid. Continued strength and rate cuts being pushed out would weigh on the group.

Quality (MS22QUAL Index) has resumed its trend of outperforming companies with debt problems (MS22DEBT Index). As a reminder, MS22QUAL is a basket of S&P 1500 stocks, sector neutral, with the highest ROE and stability of earnings. MS22DEBT is S&P 1500 companies with low interest coverage ratios, high and deteriorating short-term debt ratios, and high cash flow volatility.

MS22DEBT is correlated to 10yr yields. This group would benefit from higher nominal growth, but faces intense pressure as interest rates rise.

SMID GARP had rallied the strongest of the three swaps into CPI, but was also hit by hot data. For this group to rally, data has to prove financial conditions do not need to tighten significantly.

Our current recommendations are below.

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