Asset Class Performance During QT
As mentioned in our piece from earlier today, gold did not necessarily deliver superior performance during the last QT cycle. This leaves investors to ponder: which asset classes did deliver substantial returns? Is there anywhere to hide? Although the macroenvironment is vastly different this time around, it is still helpful to look at past occurrences to attempt to put a frame of reference around today’s markets. Major differences include rampant inflation (particularly in commodities), supply chain constraints, lapping stimulus benefits, and weakening economic data. Below, we summarize the performance of the S&P 500, bonds, agricultural commodities, and oil during previous QT cycles.
The S&P 500 outperformed Gold during the last QT cycle, gaining 19.2%, which constitutes an annualized return of 10.1%. The graph below outlines the performance of the S&P 500 ETF (SPY) during different cycles of QE and QT. As you can see, equities were not particularly steady during the last QT cycle, but SPY gained significantly after the Fed announced its intent to slow the balance sheet winddown.
In the last QT cycle, the bond market initially sold off but managed to finish higher for the entire period. The iShares Core US Aggregate Bond ETF (AGG) bottomed at a drawdown of 4.7% about a year after the cycle began but proceeded to gain 6.7% through the final 203 trading days of the cycle. When all was said and done, AGG finished the cycle with gains of 1.7%. Similar to what we saw in gold, much of the gains were seen after the Fed announced its plan to slow the wind-down of the balance sheet. This suggests that rates rose at first but then reversed course when the Fed announced the impending end of QT. So far in the current cycle, AGG has already dropped by 2.7%, but bonds sold off hard in anticipation of QT in late 2021 and early 2022. On a YTD basis, the ETF is down a whopping 12.7%.
Agricultural commodities performed poorly during the last QT cycle, dropping 15.7%. This constitutes an annualized return of -8.9%, but the broader agricultural space was in a downtrend before QT began. Currently, agricultural commodities are in an uptrend, so it will be interesting to watch the price action as QT ramps up. On a YTD basis, the Invesco DB Agriculture Fund (DBA) is up 10.2% and is essentially flat since QT began in early May.
During the last QT cycle, crude oil gained 15.8%, but it would be difficult to attribute these gains to quantitative tightening. Since the Fed began tightening this year, crude oil has jumped 16.0% higher. In the last cycle, oil rallied higher before subsequently crashing, which would certainly be welcomed by many in this cycle. Click here to become a Bespoke premium member today!
Gold Performance During QT
Quantitative tightening (QT) has wide-spanning effects on the economy, as it puts upward pressure on risk-free interest rates due to increased supply in debt markets (assuming all else equal). The Fed announced its QT strategy just one meeting (5/3/22) after hiking its target rates for the first time since 2018 back in March. The previous QT cycle in 2017 did not begin until about two years after the Fed first started hiking rates. The reason for the quick turnaround this time around, though, stems from the fact that inflation has been running rampant, and the balance sheets of consumers and corporates are in relatively strong positions.
In terms of how various asset classes may perform in the current period of QT, some investors have looked back to the prior period of QT for insight. As mentioned above, there are some important distinctions between the current period and the last period of QT, so it may not be an apples-to-apples comparison, but there are certainly some similarities that can make knowing what happened back then helpful. Using the price of gold over the last 15 years as a backdrop, the chart below shows key events related to periods of quantitative easing (QE) and QT. The event surrounding each dot is summarized in the table below. Click here to learn more about Bespoke’s premium stock market research service.
Between October 2017 and July 2019 (the last QT cycle), the price of gold rose by 12.6%, which works out to an annualized return of 6.5%. Over the last 15 years, the price of gold has held an annualized return rate of 6.8%, so there was no clear differentiation in the performance of gold during that period of QT and the last 15 years as a whole. Looking at the chart, though, much of the gains from the last cycle of QT came late in that cycle as the Fed had already announced its intent to end the running off of assets from its balance sheet. In fact, the S&P 500 outperformed gold by more than six percentage points during the last QT cycle. In fact, before the March 2019 announcement that the Fed would wind down its balance sheet, gold was practically unchanged relative to the start of the QT cycle. Click here to become a Bespoke premium member today!
Bespoke’s Morning Lineup – 6/15/22 – Fed Up
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“Everything you’ve ever wanted is on the other side of fear.“ – George Adair
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With last week’s CPI report behind us, the market shifted its focus to the FOMC rate decision, and that day has now arrived. Futures are higher heading into the report, but we just got a slug of economic data (Retail Sales, Empire Manufacturing, and Import and Export Prices). Overall, the results weren’t pretty with Export Prices the only indicator that came in higher than expected. Both Philly Fed and Retail Sales were not only weaker than expected, but they were also negative at the headline level. Economic data is going one way (down), and interest rates are going the other (higher).
In today’s Morning Lineup, there’s a lot covered as we discuss the latest moves in crypto (pg 4), the ECB emergency meeting to address spreads widening in peripheral countries (pg 4), a preview of tomorrow’s BoJ meeting (pg 4) and today’s Fed decision (pg 5), a recap of market moves in Asia and Europe (pg 5), overnight economic data in Asia and Europe (pg 6), and much more.
After four days in a row of 1% to multi-percentage point daily declines, yesterday’s 0.38% drop in the S&P 500 almost seemed like an up day. Nevertheless, yesterday’s decline was large enough to bring the S&P 500’s five-day decline to over 10% which is a magnitude of decline we haven’t seen since the COVID crash (when there were multiple). The chart below shows the S&P 500 (on a log scale) going back to 1960, and the red dots indicate any time when the trailing five-day return was greater than 10%. What’s really interesting to note about this chart is that prior to 2000, the only times since 1950 that the trailing five-day decline exceeded 10% were in May 1962, October 1987, and August 1998. Since 2000, though, these types of declines have become much more commonplace with spikes in downside volatility occurring every few years.
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Inflation Concerns Peak
The NFIB released the results of its May survey of small businesses this morning, and even though the report showed the outlook for business conditions collapsed to a record low, there were other at least partially promising signs under the hood. Primarily, the percentage of respondents reporting inflation as their biggest concern finally appears to have peaked. After reaching a record high of almost a third of responses in April, a still-elevated but improved, 28% of small businesses reported inflation as their biggest concern. The decline in concerns over inflation ranked as the largest decline of any reported problem, but conversely, “other” saw the largest increase as it rose 5 percentage points month over month. Now at 11%, that reading is near some of the highest levels on record going back to 2008 (this response does not have as long dated of a history as the others which go back to 1986)
While the percentage of respondents reporting inflation as their biggest concern has peaked for the time being, that is not to say fewer businesses are concerned about rising costs. Behind the increase in “Other”, the next biggest month-over-month increase was cost of labor which rose four percentage points. That brings it to the highest level since December on its own as well as on a combined basis with quality of labor (which was unchanged month over month).
Inflation was not the only reading to fall month over month as fewer respondents also reported taxes as their biggest concern. Alongside another government-related reading, government requirements and red tape, the combined reading is at a record low.
Government-related indices were not alone with record low readings. 0% of respondents indicated that competition from big businesses was their most pressing issue as well while poor sales and financials & interest rates are just off record lows of their own. Click here to learn more about Bespoke’s premium stock market research service.
Bespoke’s Morning Lineup – 6/14/22 – One Way Market
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“He says we’re going the wrong way.”
“Oh, he’s drunk. How would he know where we’re going.” – Planes, Trains & Automobiles
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After four days of basically getting their faces beat inside out, bulls are trying to make a comeback this morning aided in part by a PPI report that wasn’t stronger than expected. Small business sentiment also managed to come in slightly better than expected, although it remains weak. One item covered in today’s Morning Lineup commentary is the fact that inflation expectations in the latest ZEW survey didn’t show a pickup in inflation expectations for the US or Eurozone.
In today’s Morning Lineup, there’s a lot covered as we discuss trading in APAC and European markets (pg 4), whether or not the Fed will go 50 or 75 bps tomorrow (pg 5), overnight economic data in Asia and Europe (pg 6), and much more.
Over the last two years or so, the market has come full circle. In February and March of 2020, there was that five-week period where the only direction the market would move was lower. Shortly after, the Federal Government and Federal Reserve unleashed massive amounts of stimulus, and the market started to turn around. By early 2021, the market had completed a complete 180, and the only direction it could move was higher. Then, late last year as government stimulus started to dry up and the Federal Reserve started to get religion on inflation, cracks in the market started to emerge. By early this year, we were calling it a one-step forward and two-step backward market where every positive day was offset by at least two bad days taking the market to progressively lower levels in the process.
As painful as the one-step forward and two-step backward market felt, at least there were some positive days. Over the last few days, it has become a one-directional market, and the direction has been extreme in the wrong way. Over the last four trading days, the net advance/decline (A/D) reading for the S&P 500 has been negative 400 or lower meaning that in each of the last four trading days there have been 400 more stocks that traded lower on the day than higher. To give you some perspective on how extreme this type of streak is, since 1990, there have been ten years where for the entire 12 months there weren’t even four days where the net A/D reading for the S&P 500 was at negative 400 or lower. As shown in the chart below, there has never been a streak of similar duration, and the only time there were even three consecutive days of -400 readings was in August 2015 at the height of concerns over the Chinese yuan devaluation.
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S&P 500 Yields vs 10-Year
In recent years, one of the major arguments made for equity market bulls was the fact that there was no alternative (TINA). TINA was a tough strategy to argue against as fixed income markets were offering incredibly low, if anything in the way of yields, especially relative to inflation expectations. However, the Fed’s hawkish pivot has caused yields to tick significantly higher, reaching the highest level in about a decade in early June. This certainly changes the investment landscape, as alternatives to equities become more attractive and the discount rate used to revert future corporate cash flows to present-day dollars increases.
The 10-year Treasury note is now offering investors a yield of 3.4%, which is more than 2 times higher than the level at the start of the year. Notably, the current 10-year yield of 3.4% is 172 basis points higher than the dividend yield of the S&P 500 (which is 1.6%). This widening spread decreases the attractiveness of equities and increases the appeal of fixed income assets, which can lead to further downside in the S&P 500. Although the spread has moved significantly higher as of late, it is still compressed relative to historical averages, meaning that yields could still rise further and the spread between long-term Treasuries and the S&P 500’s dividend yield would be narrower than the long-term average.
Another metric worth tracking is the earnings yield of the S&P 500 versus the 10-year yield. The earnings yield (the inverse of the P/E ratio) is currently 218 basis points higher than the 10-year yield. If this spread were to turn negative, it would imply that risk-free assets would be generating superior earnings than riskier equities. Nonetheless, the S&P 500 earnings yield is still well above that of the 10-year yield, so equities do still appear attractive on an absolute basis, implying that investors are still being compensated for the excess risk taken by investing in public equities. Throughout history, there have been periods where the earnings yield was less than the 10-year yield for extended periods of time, and while this would seem counter-intuitive, unlike fixed income, where capital appreciation is capped, capital appreciation for equities is theoretically unlimited.
The chart below aggregates the S&P 500 earnings yield, dividend yield, and the 10-year treasury yield. As you can see, the earnings yield has been higher than the treasury yield since 2002. The tightening of this spread decreases the attractiveness of equities relative to 10-year Treasuries, which we have seen occur over the last several months. Click here to become a Bespoke premium member today!
Biggest Decliners Since 6/7
There’s been no hiding from pain in equity markets since last Tuesday (June 7th). As mentioned in our Morning Lineup today, the S&P 500 is on pace to decline by 1%+ on four consecutive days, and if we hold onto these levels through the close, the index will have dropped over 2% for three consecutive days. This period of weakness comes on the back of another hotter than expected CPI print, continued disruption from the war in Ukraine, and a 10-year yield healthily above 3%. As of midday, the Russell 3000 was down 9.5% since the close on 6/7 and 22% YTD.
As is the case for every pullback, long-term investors should look for beaten-down names with solid growth runways. The first step of this process is to recognize which names have pulled back the most and then begin looking for diamonds in the rough. The table below shows the 18 Russell 3000 members who are down more than 25% since 6/7 with a market cap of at least $1 billion. For the entire Russell 3000, the average stock in the index is down 24.4% YTD (median: -24.3%) and 10.44% since 6/7 (median: -9.86%). Narrowing that field down to stocks with market caps of at least $1 billion, the average stock is down 17.4% on a YTD basis (median: -20.5%) and has traded down by 10.3% since 6/7 (median: -9.8%).
The exposures of these 18 stocks are quite mixed, as the list includes both pandemic darlings (i.e. Opendoor- OPEN, DocuSign- DOCU) and some of the biggest pandemic era decliners (i.e. Carnival- CCL) and Royal Caribbean-RCL). On a median basis, these stocks trade 4.5 times sales and are expected to see revenue increase by 38.6% over the next twelve months. Of these 18 names, Beam Therapeutics (BEAM) is expected to see the largest sales decline (-38.7%) and Norwegian Cruise (NCLH) is expected to see the largest increase (449.8%). Relative to sales, BEAM is the most expensive at 37.4 times LTM sales and OPEN is the cheapest at 0.3X.
Individual stock performance since 6/7 does appears little correlated to YTD performance. As shown, only 8.1% of the variation in the percent change since 6/7 can be explained by YTD performance. Click here to become a Bespoke premium member today!
Bespoke’s Morning Lineup – 6/13/22 – More Monday Weakness
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“Come what may, all bad fortune is to be conquered by endurance.” – Virgil
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It’s not a pretty picture for risk assets of any kind this morning as equity indices around the world are down over 2%, US futures are down by about the same amount, treasuries are selling off hard, and crypto prices are down sharply. Concerns over inflation and its impact on economic growth have become heightened over the last several days, and unlike prior periods in recent history where growth has come into question, with inflation pressures as strong as they are, there is little optimism that the Fed can help to cushion the blow.
In today’s Morning Lineup, there’s a lot covered this morning as we discuss prior streaks of 1%+ and 2%+ declines for the market (pg 4), the plunge in crypto prices (pg 5), overnight movements in the yen (pg 6), action in Asian and European markets (pg 6), overnight economic data in Asia and Europe (pg 7), and much more.
The first trading day of the week has already been weak for the market, but today’s 2%+ downside gap in SPY will be, by far, the largest downside gap to start a week of the year and the largest since March 2020.
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Bespoke Brunch Reads: 6/12/22
Welcome to Bespoke Brunch Reads — a linkfest of the favorite things we read over the past week. The links are mostly market related, but there are some other interesting subjects covered as well. We hope you enjoy the food for thought as a supplement to the research we provide you during the week.
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Work
Microsoft says it will not enforce non-compete clauses in U.S. employee agreements by Akash Sriram (Reuters)
Microsoft will do away with noncompete clauses in the contracts of all but the most senior executives in the wake of research showing that noncompetes serve to suppress employee pay. The software giant also signaled it would “not resist” unionization efforts by employees. [Link]
A Full Return to the Office? Does ‘Never’ Work for You? by Emma Goldberg (NYT)
After spending two years taking care of all their responsibilities without leaving their homes, white-collar workers are calling management’s bluff when it comes to full-time returns to the office. [Link; soft paywall]
Who Killed the Phillips Curve? A Murder Mystery by David Ratner and Jae Sim (FEDS Notes)
The authors argue that labor market policies rather than aggressive monetary policy defenses of inflation targets have led to a disconnect between the unemployment rate and inflation. [Link; 36 page PDF]
Texas Tea
The world must brace itself for a further surge in oil prices by David Sheppard (FT)
Oil is continuing to rip as price forecasts soar amidst solid demand and no hope of any relief for the tight supply of crude around the world. [Link; paywall]
The Option To Write Options – A Suggestion For SPR Rulemaking by Skanda Amarnath, Arnab Datta, and Alex Williams (Employ America)
A change in Department of Energy administrative rules offers the opportunity to intervene more intensively in the oil market in order to make sure producers have confidence in a long-term floor for prices that will incentivize capex. [Link]
Violence
Rural America Reels From Violent Crime. ‘People Lost Their Ever-Lovin’ Minds.’ By Dan Frosch, Kris Maher, and Zusha Elinson (WSJ)
While cities have gotten most of the attention for recent increases in violent crime off of record lows, murders and other forms of violent crime are also soaring in rural areas across the country, suggesting common narratives for the causes that are unique to cities are likely misplaced. [Link; paywall]
Rent
Manhattan landlords are rejecting single tenants who don’t make over 160k by Tiffany Ap (Quartz)
A one bedroom apartment in Manhattan carries a median asking rent of $4k per month, meaning that with the standard margin of safety for landlords nobody making under $160k per year can rent the median apartment on the market in the city. [Link]
Tech
How AI Could Help Predict—and Avoid—Sports Injuries, Boost Performance by Eric Niiler (WSJ)
Very precise measurements of individual players’ joints are nearing the level of accuracy that could allow real-time prevention and prophylaxis against serious player injury. [Link; paywall]
Ukraine
Low, Fast And Dangerous: A Firsthand Account Of Ukraine’s Secret Helicopter Rescue Missions by Howard Altman (The Warzone)
An incredible oral history of helicopter flights that served to resupply and evacuate Ukrainian troops pinned down for a month at Mariupol’s giant Azovstal steel plant. [Link]
Demographics
Could China’s population start falling? by Xiujian Peng (BBC)
Years of suppressing birth rates in China has taken birth rates from 2.6 35 years ago to a 1.15 in 2021, lower than the US or Japan and so weak that the Chinese population will almost certainly start shrinking over the next year or so. [Link]
Investing
Highflying Tiger Global Humbled by Unraveling of Giant Tech Bet by Eliot Brown and Juliet Chung (WSJ)
One of the biggest winners of the post-global financial crisis boom in the technology industry was the monster Tiger Global complex. In 2022, though, the massive hedge fund is struggling with a legendary string of losses. [Link; paywall]
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Have a great weekend!
The Bespoke Report – 6/10/22 – CP-Oh My…
This week’s Bespoke Report newsletter is now available for members.
Every week, we show numerous charts to illustrate key trends in the market and economy in order to try and make sense of whatever is going on in the market. These days, though, only one chart matters—prices at the pump. Heading into this weekend, the national average price of a gallon of gas approached $5, a level it will almost certainly breach over the weekend. Not only are prices at a record high, but the pace of increase has been unprecedented. Since the COVID lows, the national average price has nearly tripled. Since the start of 2021, prices are up 122%, and this year prices are up 52% in less than six months. For just about every issue facing the market these days, gas prices are in some way related to it.
We jus published this week’s report which covers the meteoric rise in gas prices, inflation, and all the other issues weighing on markets.
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