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Qi's core S&P500 model suggests the index 'should' be trading at 4,491. That is fair value given prevailing economic fundamentals, financial conditions and levels of risk appetite.

Model confidence of 85% suggests macro has strong explanatory power. Moreover, the chart above shows how stable model confidence has been. SPX has been in a clear macro regime for seven months now.

The chart above is our custom model for the S&P500 including one additional variable - our measure for Fed liquidity. *

Adding in this additional factor boosts model confidence by just 1% to 86%. The improvement in the model's goodness of fit is marginal.

The change in model value is equally marginal - 4,527 instead of 4,491. The slightly higher macro-warranted model value means by adding in Fed liquidity, the market is more in line with overall macro conditions. 

The Qi Fair Value Gap is 'only' 0.6% instead of 1.4% on our core model. Spot SPX (white line above) and Qi model value (red line) in the chart above are closely aligned.

Finally, we can focus in on our Fed liquidity factor itself and track the evolution of its relationship with the S&P500.

The chart above shows the percentage move in SPX for a one standard deviation increase in the factor. in mid September, a one sigma increase - while holding every other factor constant - was consistent with a 0.5% move in SPX. 

Today the equivalent number is a 0.14% increase. So the relationship is positive, increased Fed liquidity is a tailwind, but the impact is extremely modest.

Our Short Term model employs a four month rather than twelve month lookback period. It can be more timely in volatile markets; maybe quicker to pick up liquidity injections from the Quarterly Refunding Announcement shifting Treasury issuance from coupons to bills. 

The pattern of association is the same. Fed liquidity is a positive driver but the relationship is modest.

Stories drive equities and increasingly those stories are about macro rather than company fundamentals. Qi lets you measure whether those stories hold up; whether they're fact or fiction.



* Our Fed liquidity proxy takes the Fed's total assets plus the recent Bank Term Funding Programme, less the Treasury General Account and Balance of Reverse Repos. 

We sum these, use a 200day moving average to smooth, and then introduce it as a new factor into our regular calculation, i.e. use Principal Component Regression to ascertain the orthogonal relationship between the factor and the asset price.

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.

Ordinarily, all equities want healthy risk appetite (low VIX). If these mega cap tech stocks are going to start trading as safe havens during “risk off”, we'd expect to see that sensitivity flip from a negative to positive relationship.

The chart above shows the percentage move in each of the Magnificent Seven for a one standard deviation shock higher in VIX, every other factor held constant.

There is a uniform pattern where, since early October, these tech stocks have become less reliant on risk aversion metrics. In fact, most are now pretty indifferent to whether VIX trades above or below 20.

The two comparative outliers are:

A couple of health warnings.

For most stocks, sensitivity is negative and holding steady. There are no signs of any regime shift yet. Although once again, comparative indifference could be a healthy sign.

Tesla is the outlier this time. Both because it is more reliant on VIX staying low in absolute terms; but also because the pattern is becoming stronger - TSLA is increasingly more vulnerable to bouts of "risk off".

Having a real-time quantitative measure of how these market-leading stocks trade with VIX will be a critical metric to watch in the days and weeks ahead.

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.

Some observations:

*Qi’s credit impulse does not include any equity factor so you can think of ours as excluding the wealth effect.

Rather our factors speak to the real cost of capital, the ease of obtaining credit & overall financing / liquidity levels. All measured in z-scores showing how far each factor is from its 1 year trend.

In absolute terms, some factors can be at extremes (real yields) but Qi is capturing the rate of change in each factor relative to its trend.

The macro factors included (all equally weighted) are:

* investment grade & high yield credit spreads
* Central Bank rate expectations (money market spreads)
* Central Bank QT expectations (interest rate volatility)
* the availability of US Dollar liquidity (cross-currency basis swaps)
* the level of real yields
* the shape of the yield curve
* currency strength in TWI terms

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.

That combination is all the more concerning when viewed in conjunction with the Qi investment clock which follows industry convention with one important difference. It divides assets (here global equity indices) into quadrants with each quadrant capturing a macro regime. The regimes are industry standard and follow the typical business cycle - boom, recession, Goldilocks, stagflation.

Economic growth and inflation are the two variables that dictate which regime / quadrant any equity index lies in. But the key difference is how that is measured.

Traditional investment clocks rely on the discretionary view of the asset allocator. That is probably influenced by factors such as history (behaviour during previous cycles) or fundamentals (during an energy-led inflation shock, for example, is the country a net oil exporter or importer). Such analysis is subjective and relies on history perfectly repeating itself.

Qi's proprietary version of PCA means we capture the independent pattern of association between an equity index and economic growth (Now-Casting tracking GDP) and inflation expectations (inflation swaps). Country indices are allocated a regime on the investment clock by maths not opinion.

The first standout from the chart above is how NASDAQ is in a boom regime. But while the sensitivities are smaller, what is equally striking is the confluence of European equity indices in the Goldilocks quadrant.

The Euro Stoxx 600,DAX , CAC, IBEX, FTSE MIB are all in that top left quadrant.

Again it is worth stressing the sensitivities are modest: close to zero for economic growth, while the relationship with inflation is a small negative.

But the basic point remains - if the Bloomberg consensus above is correct, this is the worst possible combination for European equities.

Is there any respite? This view focuses on just two factors - economic growth and inflation expectations. What about the rest of the macro complex?

We've observed that growth is not a major driver currently. Inflation is a top driver for these models - European equity indices need inflation to conform to target.

And that speaks to the other key drivers in the current macro regimes. Rate volatility, credit spreads and risk aversion typically screen as the three biggest factors currently. European equities need well behaved inflation, because they need the Kool-Aid of easy money from the ECB.

The pie chart above simply shows the relative importance of all the macro factors in our DAX model. A quick way to ascertain which macro factors are driving the current regime.

And it does offer some potential relief if you believe in an ECB pivot. Put another way, investors need to have high confidence that we don't see a policy mistake from the ECB that engineers a sharp tightening in financial conditions and subsequent hit to risk appetite.

The textbook Central Bank policy response to stagflation entails higher-for-longer rates and an acceptance of weaker growth while we wait for inflation to subside. For many equity investors, that will read like the definition of a policy mistake.

And sadly it is particularly dangerous combination for the region which, if the economists are right, seems most likely to experience it.

Less well publicised is that the most popular indicator of interest rate volatility - the MOVE index - closed at its lowest level since Mar 2022 on Friday.

Qi employs swaption (instead of US Treasury) volatility but they capture the same story. Higher volatility in the rates market tends to be associated with periods of stress. Obvious culprits in recent years have been monetary policy fears - the 2013 Taper Tantrum, the 2022 inflation fight.

Traditionally, higher rate vol is a headwind for risky assets like equities. So the chart above showing the collapse in rate vol in z-score terms in the US, Europe and UK is good news.

Why should equity investors care about this relatively obscure part of capital markets? Because Qi's models show that falling rate volatility is critical right now.

More important, in fact, than the level of bond yields. The chart below shows the percentage shift in the S&P500 for a one standard deviation shock higher in both 10y US real yields and US rate vol. Remember every other macro factor is held constant each time to show the true, independent impact of each factor shift on SPX.

Real yields were the story in 2022. As the Fed abandoned transitory and embarked on an aggressive rate hike campaign, real yields became the main transmission channel by which policy tightening impacted the equity market.

At its peak, a one standard deviation rise in real yields equated to a 1% fall in the S&P500. Today sensitivity is close to zero.

Meanwhile in 2023 the story has been the rising importance of interest rate vol which Qi labels 'FED QT Expectations'. It has moved in the opposite direction. S&P500 sensitivity was effectively zero over H2 2022, but factor leadership has changed and it has become a highly prominent driver.

That can also be seen in the attribution chart above. Other bond market signals like the level of real yields or shape of the yield curve have had little effect on S&P500 model value over the last month.

Instead low rate vol, tight credit spreads and the rally in crude oil have been instrumental in moving macro-warranted model value for the S&P500 up 5.24% over the last month.

That improvement in macro conditions has not been mirrored by the market. Hence the S&P500 now screens as over one standard deviation cheap on our metrics.

The case for lagged policy effects and a recession haven't gone away. Indeed, there are mounting signs that economists are capitulating on recession forecasts just as deeper cracks open up.

It is still all about Goldilocks or Bust. For now, Goldilocks still has the edge but beware a shift in volatility from the interest rate market.