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The result is that, even with spot moving higher, the market remains cheap versus Qi model value.

Those key drivers – healthy risk appetite, rising metal prices / Australian inflation – are highly intuitive given this cross is often viewed as a barometer for the global business cycle.

Most financial commentary is focusing on downside risks & a likely recession. A scenario that is not consistent with AUDJPY upside.

Qi model confidence is strong & the signal remains valid while macro fair value continues to appreciate. Economic bears will almost certainly pass on this one. But, for those looking for last week’s rally in risky assets to continue, or those thinking recession talk is overdone, AUDJPY looks an interesting play.

If traditional sector allocations aren’t working, how about a smart beta approach. Fearful of a recession? Surely if bond yields are rolling over, Growth is recovering versus Value? Once again there is a divorce between market narrative & reality – Value has yet to give up any of its 2022 outperformance versus Growth.

Maybe a new perspective is required. Qi’s unique optimiser employs best-in-class, out-of-sample tracking. It finds the combination (names & weights) of liquid single stocks that most efficiently track a target variable.

The example below is Qi’s US inflation basket. A 50:50 Long / Short basket of US blue chips that, since Jan 2019, has produced a 92.3% correlation with US inflation expectations as measured by 5y USD inflation swaps

The optimizer can be trained on any target variable. Ones that best capture your main macro scenario; or the biggest risk exposure you need to hedge.

It will provide a list of liquid stocks that closely correlate to the target, & is highly customizable: exclude individual names, skew sector allocations, cap single stock exposure to your chosen level of diversification, set a minimum liquidity constraint etc etc

Look Up™

What started with unprofitable tech is now impacting bricks-&-mortar retailers selling everyday goods; companies normally perceived as relative defensive havens.

To the extent it captures inflationary bottlenecks which compress margins, it is easy to see retailers as a warning of broader pain for corporate profitability. That suggests this is not capitulation but the market questioning future earnings growth. But where does that leave Consumer Staples as a sector?

The classic cyclical barometer of Staples versus Discretionary has just entered a new macro regime. XLP vs. XLY model confidence has risen 10% in the last 2 weeks, 18% over the last month, & now stands at 69%. Macro matters once again.

For the first time since November, Staples are cheap to Discretionary. It’s small (-0.3 sigma, -2.2%) but a notable shift. It is also worth noting that Qi model value continues to point higher, i.e. the macro environment continues to favour Staples outperforming.

In sector RV space, RETINA™ has flagged two bullish signals on XLP. Consumer Staples are now 1.7 sigma cheap versus both Health Care & Materials. That’s a record Fair Value Gap for XLP vs. XLV – we’ve never seen a dislocation this big between these two defensive sectors when in regime since 2009.

XLB vs. XLP has only been in regime & this rich to model 3x in the last 14years. The hit rate as a sell signal is 67%.

These are incredibly volatile markets that require additional diligence on any systematic signal. That said, such price action also throws up opportunities & RETINA flags where markets have moved furthest away from macro fundamentals. At a minimum, it is a source of potential trade ideas for consideration.

At the single stock level the picture is mixed. Walmart, Lowe’s & Home Depot are not in regime – company fundamentals matter more than macro currently.

Target & Macy’s are in regime but the valuation picture differs. The former is marginally above model. The latter has traded below macro-warranted fair value throughout 2022. The gap is currently 0.7 sigma or almost 10% cheap versus prevailing macro conditions.

At the sector level, macro’s influence is strong & rising. XRT model confidence is 78%. In valuation terms, at +0.7 sigma (+9.8%) XRT’s Fair Value Gap is close to 2022 highs.

However, this is not a significant level. Back-tests show a 54% hit rate & small positive average return. Essentially close to coin flipping territory.

Should we get there, selling a FVG of +1.0 sigma is more interesting with a 64% hit rate for an average return of +1.3%.

The drivers of XRT closely mirror those of the S&P500 – bulls want reflation, lower real rates, tighter credit spreads & well behaved risk aversion.

Retail could be an interesting one to watch for those who believe a bear market squeeze provides another selling opportunity.

There are two potentially interesting observations to highlight.

Every cycle is different. The Qi Vol Indicator moved ahead of the initial equity sell-off / VIX spike in January. More recently in April / May the two have moved higher together.

But, while VIX is consolidating somewhat, our Vol Indicator seems to be launching a fresh move higher. Should we see a one month increase of 20 or more, the chances of another leg in this “risk off” move could be imminent.

Put differently, to date, the 2022 bear move has felt generally quite orderly. Until this week that is when a sense of panic & capitulation has crept in.

The Qi Vol Indicator could be speaking to that next (potentially last?) & most aggressive phase of the bear move. Eyeballing the chart we are approaching levels which typically mark blow-out tops before reverting lower.