Inside Markets — Very Busy Week Ahead

A very busy week ahead is likely to inform the equity narrative for the next two months. Last week’s sharp rotation out of secular growth stocks has generated questions about when it will end.  Hedge fund turnover data from last week suggests a decent amount of positioning has been unwound but falls well short of signaling capitulation, which is needed to make a definitive call.  Semi/semi cap equipment stocks have been among the hardest hit with positioning metrics back to more reasonable levels and the group in short-term oversold territory.  While last week’s US macro data and earnings prints were generally ‘good enough’ to support a buy the dip response, the coming week is far busier in both data and earnings.

Rising expectations for a September rate cut following a cooler June CPI print on July 11 started what we define as a ‘position squeeze’ in small cap stocks.  A monetary easing cycle would be a favorable development for small cap companies that tend to issue more floating rate debt.  The current monetary tightening cycle resulted in a record wide performance differential of 30 percentage points between the RTY and SPX.  In this way, adding small cap exposure on the promise of rate cuts was a relatively inexpensive placeholder for an investment with an attractive risk/reward profile.  The first 3-5 days of any rotation starts with a short-covering rally.  This short-covering rally resulted in a +9.3% rally in the RTY and -3.2% pullback in the SPX, closing ~40% of the performance differential that developed over the last 2 years. The risk/reward today is far less attractive than it was on July 11, but our skepticism for a lasting cyclical rotation and full RTY recovery is based on a lack of confirmation in cross markets – specifically copper prices that are down ~11% over the same period.