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The challenge to come back into a strong macro regime has not been aided by last week’s hawkish central bank meetings – which has served to keep policy uncertainty high into 2023. This uncertainty will be reflected best in the sensitivity to corporate credit spreads, which remain a major driver of the index.

The prior observation that bad economic news is good news for the equities, allowing the Fed to take their foot off the financial conditions pedal, is shifting. Policy error fears are being reflected more in a greater focus on economic growth.

Qi’s sensitivity to economic growth and metals has been trending higher. If the central banks insist financial conditions need to remain tight, hard landing fears increase.

This leaves risky assets between a rock and a hard place given the resolve of both the Fed and ECB last week – weaker economic data raises the spectre of recession; stronger data raises the spectre of rates remaining higher for longer.

This likely keeps equities in a fat and flat range with bounces being sold into until the regime becomes clearer.

Qi shows stocks relative to bonds moved into undervalued territory over December – but this again a reflection of the changing dynamic and not a signal.

The relative undervaluation is precisely because bond yields and stocks have seen a more positive relationship over the last month – yields down and stocks down.

If growth fears move to the fore, the risk remains that model value remains under pressure.

The majority of GICS level 1 sectors saw spot prices move below Qi model prices by the end of last week. However, model values are showing waning momentum.

We warned on Energy trading rich in an insight note in late November – it has been the weakest sector over the last month. Energy now stands at -0.8 sigma to model value.

However, again we are wary of reading into this too much when it is the most sensitive sector to inflation expectations, alongside high sensitivity to EM FX / China re-opening.

February - More downside for speculative tech

Unprofitable tech names were the first mover in this bear market but, by Feb, had stopped falling and were attempting to consolidate.

Not on Qi.

Model value kept trending lower thereby opening up a significant rich valuation on a host of spec tech plays - FINX, CLOU, FDN, GNOM, BBH & IGV (chart).

Original Qi insight - More downside for spec tech?

March - catch up

In mid-March, on Qi’s models SPY screened as 5% cheap and QQQ was 11% below where it ‘should’ have been. Both represented significant valuation gaps and a flag that US equity indices had sold off too aggressively relative to macro conditions.

Qi model value for QQQ rose throughout March peaking on the 29th by which time the valuation gap had narrowed from -11% to just -1%. Thereafter model value resumed its downtrend.

Original Qi insight - Catch up

April - Brazil

Structurally bullish, tactically wary was the headline in our Apr 6th observation. The iShares ETF tracking Brazil EWZ was 15% rich on our models.

Even as a country set to benefit from the impact of Russia/Ukraine’s conflict on commodity markets, the machine was telling asset allocators a lot of good news was priced.

Over the next month EWZ fell almost 21%.

Original Qi insight - Structurally bullish, tactically wary

May - Bottom up meets top down: Dick's Sporting Goods

May 23rd and earnings season. Walmart and Target have already spooked markets with anecdotal evidence about inflation eating away at margins. Several US Retailers re due to report.

Qi flags that Dicks Sporting Goods is 25% cheap to model. Yes this week is about company fundamentals but a quick macro overlay identifies DKS as having discounted a lot of bad news already. Over the next three weeks it rallies 13.3%

Original Qi insight - Bottom Up meets Top Down: US Retailers

June - SPY vs. GOVT

On June 16th, Qi showed the S&P500 was at an extreme level relative to bonds. This was on top of an uptick in Qi model value for SPX. We surmised that macro conditions were improving at the margin, that SPY was cheap to GOVT and that quarter and half year-end re-balancing flows were imminent.

Over the next 8 weeks SPX rallied over 17% and equities outperformed bonds.

Original Qi insight - SPY vs. GOVT

July - Value vs. Growth & the power of macro

Low bond yields fuelled the bull market in Tech & Growth plays. So says the common wisdom. Like most truisms there is a fair degree of truth in it. But is it just about rates? What about other macro drivers?

Factor leadership changes, regimes shift, only a machine can capture the underlying patterns in real time. A nice example of how even when an equity investor thinks they’re using a factor-based approach, they’re actually running macro risk.

Original Qi insight - Proof! What Value needs to outperform Growth

August - measuring macro in one chart

The red line shows Qi model confidence for the S&P500. In bottomed and turned higher early in July, highlighting that the macro environment was ripe for a bear market squeeze.

It peaked early in August. Jackson Hole and Powell’s hawkish speech was still three weeks away but the machine was already recognising that financial conditions were shifting under the surface, getting nervous that the Fed Chair would double down on the fight against inflation.

September - How to outperform tighter financial conditions

A real-life case study showing how Qi’s macro factor sensitivities can help equity investors tweak their portfolio to avoid macro landmines.

The result? Qi’s choice of resilient stocks outperforms the most vulnerable by 7%, and the S&P500 by 3% over the subsequent 3 weeks.

Original Qi insight - How to outperform tighter financial conditions

October - Credit Impulse

Stock pickers do not have time to closely monitor shifts in the macro landscape. Qi can be your eyes-and-ears.

Our Credit Impulse aggregates financial conditions into a single measure, capturing when liquidity is being tightened or loosened.

Snapped at the end of October, our Credit Impulse suggested a large amount of the Fed’s tightening in 2022 had been unwound.

Original Qi insight - Dovish pivot? Its already happened

November - US equities: a shift in factor leadership?

For most of 2022 the message from Qi has been simple – the Fed’s tightening of financial conditions is pushing macro conditions against US equity markets.

But over the course of Q4 that pattern started to change and new leadership started to emerge – tentative signs that the real economy could become more important than financial conditions. Presumably a reflection of the market pricing in peak Fed Funds around 5.0%, and now a greater focus on whether 2023 produces a hard or soft landing.

That could imply the reaction function of equities is shifting.

For much of the year, ‘bad news’ that stays the Fed’s hand in raising rates, was deemed ‘good news’. A focus on the real economy and fears of a recession could suggest equities will start to recognise bad news = bad news.

Original Qi insight - US equities - a shift in factor leadership?

December - a big 2023 reversal?

Qi’s model value for USDJPY fx fell 1.5% over November and is down 0.9% so far in December. A pause that refreshes the Dollar bull market, or a critical new trend for the new year?

The strength of the Dollar has been a huge factor for equities in 2022. How is an equity investor supposed to keep an eye on shifts in currency markets?

Utilities versus S&P500

It's a similar pattern with Utilities outperforming the broader US equity market from January to June. There followed a retracement and a period of sideways price action.

Qi's Short Term model has just moved into a new regime - model confidence has risen from 27% at the start of October to 83% now.

Watching the blue line will be interesting. There are tentative signs it is basing. It could break either way but any upturn would suggest the broad macro environment is once again pointing to Utilities outperforming and a defensive allocation.

Infrastructure

PAVE is an ETF of US single stocks that benefit from US infrastructure projects. It is all about macro. Short term model confidence is 95%; Long Term model confidence is 89%.

And what does the macro picture currently say? There is a strong uptrend in macro-warranted fair value regardless of the look-back period employed.

There is no real valuation edge. PAVE is a very modest 0.5% below ST model value, and 1.0% cheap to LT model. But the aggregated picture of economic fundamentals, financial conditions and risk appetite point to a friendly backdrop for US infrastructure.

The second amber warning sign - if model momentum has stalled in a leader of the market rally, value gap convergence is left vulnerable to changes in the macro backdrop.

Alongside falling model confidence, Qi’s model value for the Technology sector has flat-lined over the last month. A critical barometer of confidence in any Qi valuation gap is rising / stable model confidence alongside momentum in the model itself.

Macro conditions were improving for Technology over October but now they have stalled.

The third amber warning sign – spreads are the dominant driver of the equity market in Qi’s models. However, has the reduction in risk premia left us with little margin for error?

Where model prices are rising (for example in Materials, Industrials) at the epicentre is the rally in credit spreads. Credit spreads saw their wides at the end of September and the equity low soon followed thereafter.

The largest driver of credit spreads are measures of risk aversion. The chart below shows the breakdown of macro drivers for US High Yield spreads. Risk aversion is the biggest accounting for 22% of model value.

A cursory glance of CDX HY and VIX would show both already at levels seen in mid-August when SPX was trading closer to 4200.

As another indicator of low risk premia, the SPX 12mth fwd earnings yield / bond yield gap is now at 15yr lows, last seen in 2007. One would reasonably expect that while rate volatility may well normalise next year, growth volatility will likely move higher - hence an almost unanimous Street focus on IG credit / balance sheet strength.

The fourth warning sign – factors that contributed to rally strength may now come under pressure. Unless other factors come to the fore this in turn puts macro-warranted valuations under pressure.

We monitor for which drivers are increasing in importance to explain the equity market. USDCNH is now a top three driver of SPX model value over this last month after real yields and credit spreads.

After initial enthusiasm around a re-opening trade, China's daily Covid case has hit an all time high, large parts of Beijing are under effective lockdown & protests are spreading.

Commodity cyclicals (e.g. XME in addition to Copper and Energy) already screen as rich on Qi.