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US equity managers should be aware that their allocations between Value & Growth are not simply a risk premia decision. Macro factors are equally important. Qi’s Growth vs. Value model has been in a strong & highly stable regime for a year now.

And currently the Value vs. Growth ratio (using the Vanguard tracking ETFs VTV vs. VUG) is behaving in line with macro fundamentals. There is no valuation edge.

But there is a potential top in macro-warranted model value. The strong uptrend in the red line over 2022 suggested macro conditions favoured Value over Growth. That trend may now be over.

Qi model value peaked on May 24th & has fallen 3.5% since then. All driven by falling inflation expectations & easier financial conditions (credit spreads, real rates & EuroZone spreads).

And that’s the paradox facing investors. If the Fed feel still tighter financial conditions are needed in the fight against inflation, these macro factor moves won’t last. This is a bear market rally & Growth plays can underperform once again.

The view on whether this is bear market noise or a more fundamental regime shift is yours. But the Qi framework can help identify which parts of the market have become divorced from macro.

For example, if you believe there is a meaningful rotation brewing, is there a valuation edge anywhere? XOP vs. XLC is now 14% rich to macro.

That’s because of the divergence between spot (near recent highs) & Qi model value which has fallen almost 5.5% over the last 3 weeks.

Not for tech bears (especially Facebook & Google given they account for almost half of the Communication Services sector) but an example of how to quickly spot potential trade opportunities.

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.