SUMMARY: The BoJ met market expectations by raising rates and easing its yield curve control and ETF purchases, but maintained its JGB buying program. The Yen reversed its recent gains. Expectations for tighter policy in the U.S. than RoW (European rate cuts are widely expected in June. June cuts in the US are uncertain) have supported the USD the past few weeks. The USD is biased higher unless March CPI data proves the dovish thesis that Jan/Feb inflation data were mostly seasonal. Again, the burden of proof has shifted. Investors are not assuming inflation is seasonal. They are worried inflation is sticky, which will keep rate volatility high.
Yesterday’s equity market internals were dominated by a rally in the Mag 7. And it was mostly GOOGL, which is now up +12% in less than two weeks. Days like yesterday emphasize the difficulty of shorting the Mag 7. We think Deep Cyclicals will continue to outperform Early (HERE) and prefer small vs. large size, but we would express those trades vs. equal-weighted Early Cyclicals (not cap-weighted) and vs. the OEX equal-weighted (top 100 to reduce Mag 7 exposure).
Value, Deep Cyclicals, and Small caps HAD been working together, but the change in what is driving yields (more inflation vs. economic growth, which is a change, more HERE, is more supportive of Value and Deep Cyclicals vs. Small caps. Unprofitable small caps (-5% MoM and –11% YTD), still have a deeply negative correlation to 10yr yields and have been a LARGE drag on small caps. Companies with debt sustainability concerns remain laggards as well.
We have had a series of client questions about whether the Deep Cyclicals trade is a product of investors rotating out of semis/the Mag 7. The implication being the Deep Cyclicals trade may not be durable, or at least is dependent on another set of stocks. The rolling correlation between the Mag 7 (equally weighted) and Deep Cyclicals (also equally weighted) does not support that thesis. The correlation has been increasing since 3Q23. I.e., buying Deep Cyclicals does not imply selling the Mag 7, and vice versa.
On the other hand, the correlation between Megas and Defensives has dropped significantly. So, in this case, selling the megas does imply rotating into Defensives, and vice versa.
The correlation between the Mag 7 and small caps has fallen and has not bounced. But from a level perspective, the relationship isn’t as definitive as the Mag 7 vs. Defensives. So, it is more likely that rotations out of megas are into small caps, but it’s not as clear as megas vs Defensives.
More details in the full report below…
MARKET VIEWS: The BoJ met market expectations by raising rates and easing its yield curve control and ETF purchases, but also maintained its JGB buying program. The Yen reversed its recent gains. Expectations for tighter policy in the US than RoW have given the USD a boost to start the year.
Yesterday’s equity market internals were dominated by a rally in the Mag 7. And it was mostly GOOGL, which is now up +12% in less than 2 weeks. Days like yesterday emphasize the difficulty in shorting the Mag 7. We think Deep Cyclicals will continue to outperform Early (HERE), and have a preference for small vs large size, but we would express those trades vs equally-weighted Early Cyclicals (not cap weighted) and vs the OEX (top 100, not only the top 7).
Mag 7 the Source of Funds for Defensives, Not Deep Cyclicals: We have had a series of client questions about whether the Deep Cyclicals trade is a product of investors rotating out of semis/the Mag 7. The implication being the Deep Cyclicals trade may not be durable, or at least is dependent on another set of stocks. The rolling correlation between the Mag 7 (equally weighted) and Deep Cyclicals (also equally weighted) does not support that thesis. The correlation has actually been increasing since 3Q23. I.e., buying Deep Cyclicals does not imply selling the Mag 7, and vice versa.
On the other hand, the correlation between Megas and Defensives has dropped significantly. So, in this case, selling the megas does imply rotating into Defensives, and vice versa.
The correlation between the Mag 7 and small caps has fallen and has not bounced. But from a level perspective, the relationship isn’t as definitive as the Mag 7 vs Defensives. So, it is more likely that rotations out of megas are into small caps, but it’s not as clear as megas vs Defensives.
