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Morning Notes — Rotation?


April 28, 2021

Our preference to add cyclical/value equity exposure over growth exposure started in mid-September when real yields made a long-term secular low and began inching higher.  Policy stimulus, consumer balance sheet strength and pent-up demand into a vaccine-induced reopening were the apparent fundamental drivers.  At the time, we expected cyclical/value outperformance as growth/Tech stocks were given time to grow into high multiples.  The term ‘rotation’ implies that one group/style of equities becomes a ‘source of funds’ for another.  In this case, rotation would imply a rerating lower of growth/Tech stock multiples.  For this to occur, you’d need to see a substantive change to the inputs of valuation models. The input with the most leverage is bond yields. Lower yields drive a higher terminal value, while higher yields have the opposite effect.

More: In December, we established ~1.45% as the 10-year yield level where high multiple stocks would struggle and cyclical/value outperformance would become more apparent. The recent consolidation in yields has helped high multiple stocks recover somewhat with the Nasdaq 100 (NDX) able muscle out a new high two week ago.  We’d expect more relative weakness from growth stocks and greater outperformance from cyclical/value stocks once 10-year yields extend through ~1.65%.  And performance divergence or rotation will become more acute if/when 10-year yields push through ~1.90%.

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