December 9, 2020
Bond yields: Tomorrow’s ECB meeting may be the most well-telegraphed monetary policy events of the year. In anticipation of tomorrow’s policy decision, Eurozone bond markets have spent the last ~3 weeks pricing in generous stimulus expectations including a 12-month extension for its Pandemic Emergency Purchase Program (PEPP) with a €500B increase in committed purchases, plus additional TLTROs. Eurozone yields have been falling in anticipation of these measures, anchoring US bond yields as well. The set-up for tomorrow’s meeting probably makes an inline decision a ‘sell-the-news’ event that could push Eurozone and US yields higher. Expectations for incremental easing at next Wednesday’s FOMC are almost non-existent, with an in-line outcome possibly accelerating the move higher in yields. This could be positive for the cyclical/value equity theme, but also has the potential to trigger a re-rating in high multiple stocks.
SPX: Equity sentiment reached bullish extremes three weeks ago and the SPX is now short-term overbought. In our experience, periods of extreme bullish sentiment have often been followed by ~8-12% equity market corrections with many of those corrections triggered by sharply higher bond yields.
Rotation? Over the past three months, we’ve avoided the term ‘rotation’ when characterizing our preference to add cyclical/value stocks over growth/momentum names. The Tech sector saw rapid multiple expansion to all-time records during the spring and summer, but this stopped in early September, kicking off a phase when the better growth stories could grow into their multiples. We still see that happening for the best growth stocks as a vaccine-induced cyclical recovery clearly wouldn’t hurt business. We avoid companies with negative operating margins regardless of economic conditions, but see those names as particularly vulnerable given our expectations for gently higher bond yields and curve steepening. But a vaccine-induced cyclical recovery with sharply higher bonds yields is also a plausible outcome that could result in a more violent cyclical rotation that leads to a rapid re-rating in growth stock multiples.