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Morning Notes — Rotation


February 16, 2021

Our preference to add cyclical/value equity exposure (Industrials, Materials and Financials) was initially based on real yields bottoming back in mid-September. It was an unpopular position in mid-September, but not anymore. We gained conviction in the cyclical/value equity call after the PFE/BNTX vaccine data pushed the S&P 500 Value Index through long-standing pattern resistance on November 9. And we gained more conviction when Georgia election results pushed fiscal spending expectations higher and drove the 5-year/30-year Treasury yield spread (proxy for slope of the yield curve) through resistance at ~130bps. The realization that Democrats would use reconciliation on Biden’s ~$1.9T ‘rescue’ package took the spread through ~140bps and we narrowed our focus to adding Financials, primarily regional banks.  The yield curve is steeper this morning, but the 5-year/30-year yield spread of ~154bps remains below technical resistance at ~155bps.  We don’t expect the 5/30 spread to immediately release through ~155bps, but we were surprised by the ease in taking out ~140bps.  The deepest value sector is Energy and expect relative outperformance from the group when it becomes apparent (two weeks) that vaccinations have broken the link between mobility and infections.  

Rotation: The rapid multiple expansion in many Tech stocks during the spring and summer ended on September 3 when CIEN issued bad forward guidance. It was apparent that Tech multiples stopped expanding on that date and the Tech sector needed ~2-3 quarters to grow into their multiples.  At the time, there was ample cash on the sidelines for investors to add cyclical/value equity exposure.  But that’s now changed with the most recent fund manager surveys showing cash levels at 8-year lows.  Rotation out of defensive groups (Consumer Staples) and bond proxies (Utilities and REITs) has already begun, and Tech may be next. Software looks particularly vulnerable with the industry trading at an all-time record ~12.1x revenue and the SaaS sub-group trading at ~18x revenue.  And two high-profile SaaS companies reported decelerating Q4 revenue growth last week.

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