Macro Report/Insights: Equities and Steepeners
Macro vol
There is a huge difference between planning and execution in the moment. When you are in the moment, it is difficult to see and think clearly because the “fog of war” surrounds what is seen and unseen. On top of this dynamic, we typically think we will perform better in the future than we did in the past.
If you simply plan and have foresight with the understanding that it will be more difficult at the moment and you won’t perform as well as the high end of your expectation, it helps you have more clarity and foresight when the moment comes. This is difficult and specific aspects of it are only learned through practice even though the outcomes and scenarios can be learned without experience. The execution under uncertainty, chaos, and fog is what creates the divide between knowledge and practice.
Equities:
We are in a moment of time where you want to be careful taking a big swing in equities or bonds. As I noted in my recent articles, equities are neutral in my strategies.
Why? Because there are two inputs into the attribution of returns in equities: earnings and valuations. The earnings side is driven by growth and its diffusion to sectors. The valuation side is driven by liquidity. I broke this down in the interest rate report:
Notice the most recent steepening in the curve has dragged down ES marginally (ES inverted in the chart below):
When you look at the attribution of returns for the S&P500, each component typically takes turns creating returns. YTD, the primary component causing SPX returns was valuations. When you get overextended in valuations then it means equities will have more sensitivity to the liquidity side of things. Bottom line, as equities, have a more of a deviation away from the mean with valuations, they become more sensitive to moves in rates, especially given the environment we are currently in (there are some qualifications for this but we are talking big picture).
I have been talking about the steepener trade for A WHILE now in the alpha reports:
Z4Z5 continues to rally:
Along with U4U5:
I noted the trades I am running this week in the “Trade” section of this article: link
A key thing to be watching is stock-bond relative performance in connection with the curve steepening:
“Clear thinker” is a better compliment than smart
-Naval
