Morning Notes — Countertrend Ending

Countertrend: The recovery in growth stocks over the past three weeks followed lower bond yields based on technical flows (CTA positioning), worsening global coronavirus trends (India and Turkey) and a slow European vaccine rollout. The Nasdaq 100 (NDX) bounced off of technical support at 12,200-12,400 in early March with an ensuing rally and successful test of the February high.  The S&P 500 was another beneficiary of lower yields based on its heavier growth weighting.  The countertrend rally in growth sectors is now nearly exhausted and we expect the NDX will struggle to make highs going forward.

Now: The equity narrative will shift from reopening to reflation as Europe begins to ease restrictions in coming weeks on decelerating case counts and improving pace of vaccinations.  The Eurozone recovery is starting from a lower base (March composite PMI just crossed into expansion territory above 50) and the acceleration will likely feel more acute.  Bond yields will move higher, the yield curve will steepen and investors will rotate away from growth and back to cyclical/value sectors.  Expect the move to accelerate into late-May/early June with Financials, Materials, Industrials and Energy as primary beneficiaries.  The S&P 500 Value Index (SVX) will outperform the S&P 500 Growth Index (SGX) and the Russell 2000 (RTY) will outperform the S&P 500 (SPX).  This isn’t the consensus view and is not currently priced into markets.  Expect the relative outperformance in the SVX to be larger than what occurred in Q1 as conditions become more apparent to more people.

Sentiment: Our primary concern at the moment is elevated/extreme bullish equity sentiment with last week’s AAII survey showing a bullish reading of 53.8, which is just below the prior week’s all-time record high of 56.9.  Last week’s survey also recorded bearish sentiment of 24.6, just off the prior week’s record low of 20.40.  Equity sentiment is a proven contrarian indicator at extremes with current levels elevating our awareness to internal and cross-market dispersions that tend to precede corrections. With the prior paragraph in mind, we see the potential for growth/NDX underperformance to drive a gentle unwinding of bullish sentiment rather than a sharp, broad equity correction.