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AAM Viewpoints – Oscillations in the Trendline




In the past, when a change of leadership occurred the previously dominant form of investing was always touted as just taking a respite from a continuation. Hence, I conclude their argument as: oscillations within a trendline does not constitute an end of the line. However, certain conditions do need to be addressed in viewing the potential for tactical changes in leadership.

Many times throughout history there have been these battles and oscillations. Currently, we see it in the Growth and Value battle. Consider the double top in the transition in 2009 before Value went on its last period of outperformance.

S&P growth index/S&P value indexOn a longer-term scale, consider the global economic growth relative to the commodity index. The profound underperformance of commodities in light of a lengthy economic expansion seems to affirm our view of a once-in-a-generational opportunity in commodities.

World GDP Dollars | Bloomberg Commodity IndexThe market forces are currently relaying diametrically opposite messaging from where current data points are indicating. Hence, the market is always pricing in future events to justify market moves that appear counterintuitive. In my previous commentary regarding the inconceivable inflection detailing three distinct measures (GDP, Inflation, and the Fed Funds Rate), I looked to point out just how dynamic the historical measures are as well as the compression in the yield curve.

Two areas that are corroborating the vast difference between market movements and fundamental results are Treasury prices, as well as their corporate debt counterparts and earnings results.

When one considers the price movement in the last nine months on the old 10-year and 30-year, one begins to understand the Tempest in the Teapot saying. Many monitor the rates on these instruments but have not paid close enough attention to the absolute price movements in these benchmarks for a multitude of debt and asset markets.

 

Price at Nov 2020 issuance or date

Low price change (date)

Current Price % from Low

Total % change from Issuance

Nov 2030 old 10-year

$99.00

-6.7% (03/31/21)

5.51%

-1.51%

Nov 2050 old 30-year

$99.68

-17.23%

15.15%

-4.70%

AA Bloomberg Barclays Corporate

$111.86

(11/10/2020)

-5.10%

4.43%

-0.93%

BAA Bloomberg Barclays Corporate

$113.55

(11/10/2020)

-4.10%

4.01%

-0.02%

Source: AAM, Bloomberg data as of 07/19/21 | Past performance is not indicative of future results.

So, in a time of historic change in the debt markets from the reopening recovery, the most volatility was within the Treasury market while corporates (whether high grade or barely investment grade) saw a fraction of the volatility. There are many subtle reasons for this difference, however, the larger argument is that credit quality was on an improving trajectory, the Federal Reserve’s quantitative easing skewed traditional risk metrics and the added fiscal stimulus allowed many companies to refinance at much lower rates, lowering leverage ratios and net interest cost. These are all longer-term positives for corporates but the lack of price movement coinciding with Treasury moves means spreads narrowed to historically low levels. This disparity and longer-term consequences confirm the need to have seasoned managers who are nimble in their structure to manage not only duration, but the three C’s: convexity, correlation, and credit.

While the influences on the domestic Treasury market are profound, globally net flows into bonds and equity are showing just how the swollen flows of liquidity gains can lead to massive price changes in debt and assets. Consider that the year-to-date net flows globally into bonds and equities is at its highest in the first seven months than all but annual total since 2007.  

Global equity flow | global bond flowMoving onto corporate earnings, and we see patterns of massive growth in earnings expectations from the recovery. This also has helped elevate 2022s expectation. The long history of earning expectations has typically shown elevated optimism in the coming year only to have it ratchet down as earnings growth and GDP failed to meet expectations. The current year has been the opposite, from the anemically low base case of 2020 and the reopening of the economy. Earnings expectations are some of the highest we have seen, though it all must be taken with a grain of salt. Perhaps the one point that should be noticed is elevated expectations for next year. The pricing in of earnings growth has hit the markets a bit with the new concern about the COVID-19 delta variant and potential short circuiting the growth from reopening the global economy.

Higher Hopes | S&P 500 earnings projections show biggest increase in decadesWhat may have changed regarding earnings outlooks is that a more cautious tone will dominate the outlooks as the uncertainty of the delta variant and the recent economic shutdowns mean storing acorns for a potential early winter may be wiser than projecting warm beach weather for upcoming vacations. While input costs have come down a bit, the supply of goods is still problematic and means a potential limit to consumption in certain areas. A key area in the results of the second quarter will be gross margins to see what pricing power corporations have and to see if it matches what we saw in the first quarter.

During volatile times there is a reckoning as assumptions are recalculated. Just as we saw with the interest rate market in the second quarter and most recently with the technical and abrupt change in reflation assets, one now must consider what assumptions are priced in and probability they occur. When assets are priced for perfection, perfect execution will maintain their value at best. Re-emphasizing the value of assets appears more important than ever and looking at oscillations within a trendline to emphasize these long-term trends appears to be an attractive adjustment to the long-term trend.

CRN: 2021-0708-9298 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

 


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