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Higher real rates are the next biggest contributor & the only other factor with a 1% plus impact on model value. This bear move is about tighter financial conditions, both at home & abroad.

A key premise of Qi is that to better predict future price levels, you need a robust understanding of what is driving price action today. For US equity managers that means focusing exclusively on inflation, as important as that is, risks taking too narrow a view.

In sporting terms, it’s the same as man-to-man marking leaving you vulnerable to not seeing the plays being run behind your back. Qi offers you the chance to play zone defence with one click of a button.

However, for those who see VIX back near trend as a sign of complacency, this chart will prompt a search for defensive trades. To that end it is worth noting RETINA™ has just flashed a bullish signal on US Health Care.

The chart below shows US Health Care is now 1 sigma (3%) cheap to macro. That FVG has opened up because the recent fall in spot has occurred despite macro fair value moving sideways.

In RV space, XLV vs. SPY is not in regime & the Valuation Gap is ‘only’ 0.6 sigma (2.3%), but that is the first negative FVG in 2022. Won’t appeal to everyone, but food for thought for those with a defensive mindset.

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

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