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Qi's model for IGV has 79% confidence. This latest regime started at the beginning of May and confidence has been pretty stable since then.

On current patterns, the Software sector is dominated by a desire for reflation, rate volatility to remain contained and credit spreads to tighten. Software loves Goldilocks.

The Fair Value Gap is +1.1 standard deviations which currently translates into IGV standing 7.8% rich to overall macro conditions. In short, and from a pure macro perspective, a fair amount of good news is in the price.

The chart above shows IGV relative to semiconductors. The white line is the spot price of the IGV/SOXX ratio; the red line is Qi's macro-warranted model value for the pair. 

Once again IGV wants reflation. Higher inflation expectations are consistent with Software outperforming Semis. The recent fall in inflation expectations are the biggest reason for the 3% fall in Qi model value over the last month.

That decline in model fair value stands in sharp contrast to the recent spate of IGV outperformance. Hence a 8.7% rich valuation on Qi.

And finally we show Software versus the broader market by modelling the IGV/SPY ratio.

The desire for reflation is there again but this time other factors have worked to offset the drag from falling inflation expectations. The net result is macro momentum has eeked out a 0.9% gain on the month. 

And once again, the recent rally in IGV has outstripped where aggregate macro conditions say it 'should' trade. Software screens as 6.5% rich relative to the S&P500 on Qi.

This is not to dispute the idea that the second wave of the AI revolution could provide a huge benefit to software stocks. The AI theme is not going away in 2024.

It is a warning that, should the mood of the market turn down, then IGV looks vulnerable from a tactical perspective. More specifically any scenario that speaks to sticky inflation, rising bond vol and wider credit spreads poses a risk.

Even bottom-up or thematic investors should know that, with Payrolls on Friday and the Fed meeting next Wednesday, the macro angle needs to be factored in.

But the Euro has quietly rallied almost 2% in October. That would appear to contradict the narrative about comparatively weak European growth. It's also taken place against a backdrop of US nominal yields moving higher than their European equivalent.

So what is driving things?

When we look at Qi model value for EURUSD we can see it bottomed at 1.0463 on Oct 19th and has subsequently bounced almost two big figures.

The biggest driver of that move?

Partly that the initial "risk off" move - credit spreads and China stress - hasn't gotten any worse. But the main push behind macro model value has come from relative inflation expectations.

The chart below shows the difference in European and US 5y inflation expectations in z-score terms. EU inflation expectations are now almost 2 standard deviations below trend versus their US equivalent.

The market is starting to price a hard landing in Europe.

Now at some point that disinflationary scenario will probably become a headwind for the Euro. Similarly a renewed surge in US nominal yields or credit spreads legging wider both have the power to shift macro momentum once again.


But the recent pattern suggests real yields have mattered more and are currently favouring higher EURUSD.

There is no valuation edge - spot is trading in line with macro conditions - but a good example of how important it is to understand exactly what it is driving markets.

This chart from Apollo looks at the maturity profile of different US equity sectors across both Investment Grade and High Yield credit.

There are several useful observations to be drawn but, regardless of credit quality, Transport and Real Estate stand out as two of the more vulnerable sectors; Telecommunications and Energy emerge as ones that are comparatively immune from any "refinancing cliff".

Qi's unique factor sensitivities can augment this kind of analysis to help complete equity risk managers' stress tests.

Every US equity sector model on Qi includes US High Yield spreads as a driver. In traditional risk jargon, US HY is a descriptor within the US equity model.

More specifically, we measure the percentage impact on any ETF for a one standard deviation shock higher in CDX US High Yield spreads.

Given Apollo's findings we zoom in on four sectors - Transport, Real Estate, Telecommunications, Energy - and chart their historical sensitivity to HY credit.

The clear standout is Transport. Holding every other factor (descriptor) unchanged, a one standard deviation widening in US HY equates to a 0.8% fall in IYT.

It is by far the most sensitive sector. So, not only is it a sector that faces a relatively large refinancing cliff in 2024; it is also one that is highly sensitive to shifts in credit spreads.

We would finish by adding that US HY is the biggest single negative driver for Qi; and credit at the bucket level (i.e. adding in European and Japanese credit spreads as drivers / descriptors into the model as well) is the biggest in our model. Credit spreads account for almost a quarter of model explanatory power alone.

Real Estate screens as the second most vulnerable. A one standard deviation shock wider in US HY spreads, holding every other macro factor constant, is consistent with a 0.5% fall in IYR on current patterns.

Again credit dominates the current macro regime, both as a bucket and with High Yield as the biggest single negative driver.

Of the two "safe" plays, Energy XLE is noticeable for its comparative indifference to credit spreads. A useful property if you fear credit crunch fears escalate.

Telecommunications IYZ may not face any supply concerns in terms of issuance. And sensitivity is small, but it is starting to pick up.

These sensitivities can be run across any macro factor which you deem the most likely theme for the months ahead. Thereby empowering risk and portfolio managers to get a better handle on tail risk scenarios they wish to stress test.

So the bottom-up view looks constructive, what's the macro picture for insurers?

At the industry level, Qi models IAK - the iShares ETF that tracks the Dow Jones US Select Insurance Index.

What stands out in terms of the macro regime, are insurer's defensive properties:

Focusing on rate volatility given it's importance in this recent re-pricing of the bond market, the chart below shows how IAK is comfortable with rising rate volatility.

That stands in sharp contrast to some others, notably Technology with market leaders like XLK and XLC increasingly vulnerable to our Fed QT Expectations factor.

It's a similar picture when we screen for sensitivity to credit spreads. IAK's defensive traits are clear to see.

The net result of that is that overall macro-warranted fair value has actually moved up during this recent period of equity stress.

The indexed chart below shows Qi model value for IAK versus the broader Financials sector XLF, Technology XLK and Communication Services XLC over the last year.

Financials and insurers took longer to recovery after SVB etc and missed out on the AI-driven rally in Tech over Q2/Q3.

But during the most recent equity market wobble, IAK has seen macro conditions grind higher.

There is no strong valuation edge. Qi's model shows IAK at macro fair value. For now, the bigger focus is rising macro momentum.

But an example of how 2 minutes spent on the Qi platform gives bottom-up investors a chance to head into earnings season better prepped.

There's no replacing fundamental analysis, but its equally important to get a quick sanity check on macro dynamics.

The spike in bond yields in Q1 culminated with the mini banking crisis and SVB / Signature / Credit Suisse hitting the headlines.

That leaves investors nervously watching for where the next pocket of stress will emerge.

The 2 minute video above shows how a Watchlist can be created with your curated list of assets that you deem the best proxies for financial stress.

And how that list provides a quick and easy way to eyeball where:

1.) macro conditions are important
2.) which assets are already pricing in bad news
3.) which assets are potentially complacent and therefore vulnerable?

Speak to your Qi sales contact to get the "What breaks next?" Watchlist and/or learn how to customise your own.