Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Inflection pivotal as vaccine pump fades
Summary: With the vaccine pump fizzling, we still remain on alert for a development of more two way price action, particularly within the high flying technology sector.
As we spoke about earlier in the week, the vaccine pump was very much needed given risk sentiment was looking very fatigued. The release of another vaccine breakthrough from Oxford scientists this morning has been met with less vigour than the Moderna hype and the boost to risk appetite is fading fast. This perhaps serves a warning of a resumption of the fading momentum we spoke about earlier this week.
As we said yesterday, we look to fade vaccine optimism, and tactically reduce positioning in the technology sector, taking some money off the table in the highflyers. Adding some more cyclical/value exposure, relative to growth/tech/momentum. Given extended growth vs. value positioning and sentiment, there is plenty of opportunity for more two-way price action here – particularly with earnings incoming, of which Netflix will be key tonight. Extended valuations leave little margin for error should the companies disappoint lofty expectations.
The richly valued names that have flown higher, being best positioned for the digitisation/Saas/cloud/e-commerce/online trends that have been accelerated by COVID-19. Alongside lower debt levels, higher free cash flow yields, and earnings duration profiles with high forecast future cash flows in the current interest rate paradigm that allow richer valuations are beginning to stage decent reversals from sharp upwards trends. Nasdaq 100 volatility is also beginning to diverge, alongside Mondays price action and a sequence of higher highs over the prior week on declining volumes, we stand by the tactical positioning we outlined earlier this week. Although we believe the companies leveraged toward these secular growth thematics will outperform in the longrun, valuations and excessively one sided positoning at present make us tactically cautious.
With the reversal in technology stocks and by default momentum/growth comes the potential for a more broad based risk-off move, as momentum works just as easily in the opposite direction.
Complacency reigns for now, but risk builds slowly, and when sentiment shifts, liquidity quickly disappears. Then the previous stability in the seemingly never-ending melt up is destabilizing in itself, with everyone rushing for the exits at once. Particularly following the increased retail and hot money participation chasing momentum in the high-flying stocks, which increases the risk of compulsive selling when sentiment shifts. Long growth/short value positioning is at historical extremes and a reversal in this positioning could be painful, with a correction well overdue.
The key for whether the tactical move is one of profit taking in tech and a rotation toward vlaue/cyclicals OR whether profit taking across some of the high flying momentum names spurs a more broad based risk off move, may well lie with the fate of the USD. As our head of FX strategy John Hardy notes, the USD is at pivotal levels for confirming a real trend in USD weakness, heading into the all important EU Council summit on Friday and Saturday. The risk of a move higher in the USD likely having the capacity to spur sectoral rotation toward more broad risk off. Again, one sided position in EURUSD reveals the risk of disappointment should the recovery package deal prove less of a slam dunk, as has been hinted via the continued resisitance from Austria and the Netherlands.
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