Morning Notes — Value/Growth Ratio Close to Breakout

SPX: The recent pullback in the S&P 500 looks very similar to the one from late January, which ended up being a buying opportunity.   Both pullbacks were preceded by decelerating price trend momentum and both looked like a pause in an ongoing bull market.  The difference this time around could be leadership with Financials, Materials and Energy pushing higher, while growth, defensive groups and bond proxies lag.  The combined weighting of Financials, Materials and Energy is only 15.31%, so their leadership could translate into a slower advance for the broad index.  This scenario has been our expectation since real yields bottomed in mid-September.

SVX: Since mid-September, the S&P 500 Value Index (SVX) has outperformed the S&P 500 Growth Index (SGX) by 802bps and outperformed the broad SPX by 452bps.  While we consider that ‘good hitting,’ there’s reason to believe SVX outperformance may soon accelerate as the Russell 1000 Value/Growth ratio looks ready to break out from a 9 month base. A breakout would make this the first inning of the value rally.

Bond yields: At 1.367%, 10-year bond yields are currently testing the upper limits of our 1.30%-1.35% resistance level. The slope of the yield curve is also testing the upper end of resistance (162bps) with the 5-year/30-year Treasury yield spread at 162.3bps.  Like yesterday, we expect both to fade into the close.  Most of the backup in bond yields has been based on economic optimism ahead of a full reopening, but some may also be due to future inflation concerns.  The next piece of inflation data comes this Friday with the release of January PCE.  Bond prices are extremely oversold, so the bar for a rally seems pretty low.  An in-line print of +0.3% month-over-month with the core rate +0.1% would deliver a +1.4% year-over-year rate, which is well below the Fed’s 2%+ target.  Any pause in the recent yield backup could lead to a pullback in cyclical/value stocks, which we’d use as an opportunity to add exposure.  Ultimately, we expect 10-year yields to advance toward 2% by year end and we expect the 5/30 curve will steepen further.