From the Desk of Ian Culley @Ianculley
It’s been a lonely rise for interest rates.
The stocks and commodities that tend to accompany rising yields haven’t kept pace since early spring. Rates across the curve have accelerated higher, leaving these risk assets in the dust.
But the seasons have changed – and the dust has settled.
Cyclical value sectors have found their footing in recent months. Now, they’re playing catch-up.
One of the strongest market themes in recent weeks has been the reemergence of value over growth.
Check out the overlay chart of the 10-year US Treasury yield $TNX and small-cap value $IWN versus small-cap growth $IWO:
The 63-day correlation study in the lower pane highlights the strong relationship between these two charts.
At a glance, they appear quite similar. But their positive correlation began to erode in late March, reaching negative territory by September.
The decoupling between yields and the outperformance of value sectors has been one of many intermarket relationships in conflict with the rise in rates. But, in recent weeks, this relationship has moved back on track.
With cyclical areas kicking into gear (from metal and mining stocks $XME to regional banks $KRE), it’s no surprise the correlation between the IWN/IWO ratio and rates is turning positive!
As value overtakes growth, we're seeing strong confirmation of this relative trend at the sector level.
Here’s a quad-pane of the industrials $XLI, financials $XLF, energy $XLE, and materials $XLB sectors breaking out relative to the S&P 500:
The relative strength of these value-oriented sectors accords with the rising-rate environment. It’s quite likely these stocks will assume secular leadership roles during the new bull market.
Of course, other sectors will join in on the rally as healthy participation provides the foundation for sustainable uptrends. To quote the great Ralph Acampora, "Rotation is the lifeblood of any bull market."
His statement is just as true today as when he said it. And we don’t expect that to change during this or any other cycle in the future.
Tech’s monster move today is a great example. It’s up almost 7% heading into the afternoon session, receiving a much-needed boost from falling US Treasury yields.
It’s hard to find a worse area of the market than tech or communications. But that doesn't mean we're going to have a new bull market without these growth names.
What we're really focused on is where the leadership will be when stocks finally carve out a durable bottom and kick off a new mark-up phase.
For now, the evidence is pretty clear that it will be the value and cyclical groups we just discussed.
We’ve highlighted which assets should outperform in a rising rate environment for more than a year.
After a period of choppy conditions – let’s call it a bear market – these stocks benefiting the most from climbing interest rates are beginning to display relative strength once again.
It’s impossible to overstate the bullish implications of this development and the tone it sets for the stock market’s future ascent.
If interest rates remain elevated in the coming quarters and years, you’ll want to trade in your tech stocks for old-school value names. Those stocks will likely become the market’s new high-flyers.
Stay tuned!
Countdown to FOMC
Following today's CPI print, the market is pricing in a double-hike in December, followed by a single-hike in February.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
This data is from the CME FedWatch Tool as of November 10, 2022.
Thanks for reading. And please let us know what you think. As always, be sure to download this week’s Bond Report!
