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1. A fragile equilibrium for risky assets?

Falling Risk Aversion and tighter HY credit spreads have been at the epicentre of higher Qi model values for risky assets over the last month. This rally has not been about economic growth expectations - see the first chart showing the 1mth drivers of SPY model value. Further, Risk Aversion and HY credit spreads are the largest SPY macro exposures.

3 Qi observations to show why this is a fragile equilibrium:

1. The ST model Qi FVG for the ETF UVXY (ProShares Ultra VIX Future) i.e. Risk Aversion itself is almost 1 sigma cheap, which is at the bottom of its 12mth range. Nov'23 was a poor signal for vol as Rsq fell sharply in the aftermath of the Fed Pivot and QRA announcement. This time around ST model RSq has been rising.

2. The ST model Qi FVG for CDX HY credit spreads is also at the bottom of its 12mth range. Qi shows the biggest widening driver of credit spreads are higher vol, higher real yields, a stronger dollar and higher rate vol. Below see the FVG vs. spot price of CDX HY spreads - again the same point that there is not much risk premia to harvest.

3. Tech has been the sector leader of the rally over the last month. Qi shows the QQQ as cheap to model value in mid-April BUT today it is rich at the upper end of its historical range. The burden is high on NVDA.

2. AI Party in the most boring sector – Utilities – very rarely has the sector been richer on Qi

US Utilities have been among the best performing sectors over the last month, last 3mths and YTD! The sector’s relationship with bond yields has completely broken down. The first chart below shows the sector’s Qi sensitivity to US 10yr real yields – the most positive it has been since 2009. The second chart shows Qi’s FVG – we hit the second highest FVG since we have data from 2009.

The narrative shift on electricity producers is based on AI data centre power demand. Some discernment is necessary though on the sector which is showing signs of exuberance. As consumer facing businesses, many utilities typically received regulated returns on regulated assets (outside of independent power producers). Many also are faced with ageing assets just as the cost of capital is rising.

Are Utilities really AI stocks?

3. Trump not seen as a risk for stocks – indeed, the Qi sensitivity to a Trump Win is positive

Qi’s macro factor models are customisable. With this in mind, we created 2 variations of our Qi model for SPY. The first including the daily time series of Real Clear Politics betting odds for a Trump win. The second for a Biden Win.

The first takeaway is that rising Trump odds is seen as a positive for risky assets. Empirically, see below simply overlaying Trump betting odds vs. the S&P 500 index. Secondly, that sensitivity has been rising since February. Over the second half of 2023, rising Trump winning odds was seen predominantly as a negative driver and it switched early this year. See the second chart. An SPY model including Biden Betting odds, reveal it as not a driver at all currently for stocks. See the third chart. Also of note is that we included Trump odds in a Qi model for EURUSD - a Trump Win is seen as USD negative.

Arguably, this reflects the market’s belief on Trump pursuing again expansionary policies and being pro tax cuts (despite the size of the fiscal deficit and follow-on risk to inflation). After all, we have already seen Trump take credit for 2023 market gains, saying “This is the Trump Stock Market…investors are projecting that I will win, and that I will drive the market up.”

4. Re-rating FX

Qi flagged bullish signals on EURAUD & GBPAUD at the end of April. In both instances, model value was flat-lining while Aussie strength saw the crosses sell-off further than aggregate macro conditions warranted.

Yesterday’s sticky core & services CPI print in the UK was the catalyst for a catch-up. From 2% cheap to model a few weeks ago, GBPAUD is now ‘just’ 0.5% cheap.

The mileage for a further correction sits in EURAUD at these levels. It still sits 1.4% cheap to the broad macro environment.

In terms of new signals, note USDCHF now screens as 1.2 sigma (2.6%) rich to macro conditions.

The cross can be thought of as a battle between two safe haven currencies. And, on current patterns, higher risk aversion benefits the Dollar over the Swiss Franc.

And it is because VIX is sub 12 that Qi model value has declined and spot has ignored that move lower. Hence the Fair Value Gap.
Historically, there have been 29 instances when USDCHF has been in regime (RSq > 65%) & this rich in FVG terms. So crudely we get this signal twice a year.
And the signal has a 66% hit rate & posts an average return of +0.77%.

5. United Health Group (UNH) – looks rich to macro valuation after positive earnings

• UNH has moved up strongly after modestly positive earnings
• However, the macro valuation has declined consistently over the last 10 weeks from $525 to $462
• This makes UNH 9.4% rich or 2sigma rich to Qi fair value (chart below). This FVG has done an effective job of catching local highs & lows.
• UNH is sensitive to stronger GDP and steeper curve but wants lower inflation; it is also defensive in the face of volatility and QT
• The share price is still trending strongly upwards but is now dangerously ahead of the fair value.

#1. Good news is still bad news – Qi sensitivity of S&P500 to US GDP growth is negative

Through April, Qi has shown the rising sensitivity of risky assets to financial conditions (rather than growth expectations). The S&P 500 Macro Beta Impulse has been rising. Last week also showed that the enemy (unemployment) of my enemy (inflation) is my friend and FCIs subsequently eased.

The bigger question going forward may well be when do growth concerns replace the soft landing / rate re-pricing narrative? We are not there yet – indeed, there is no straight path from no landing to recession concerns. Consider that as the Citi US economic surprise index has fallen below zero, stocks have rallied and VIX is at13. Economic growth expectations is a small share of the SPY macro sensitivity pie currently.

Through the Qi lens, a few observations (1) the majority of US GICS level 1 sectors want lower GDP not higher (2) SPY sensitivity to GDP growth is close to long term range lows (3) currently the top driver for the Qi short term model of UVXY ETF (VIX) is higher US GDP growth!

#2. Rate cuts today versus economic growth tomorrow – FX implications

The same question can be asked in FX markets. For a long time now the only game-in-town has been comparing the different reaction function amongst Central Banks - which Western Central Bank cuts rate first? Which cuts rates the furthest?

Relative interest rates will always be critical for currencies but, as above, investors need to be on guard for when the narrative shifts to forward growth prospects. Put another way, is there a point where FX markets move away from exclusively focusing on respective interest rate levels; & possibly towards rewarding currencies with improved growth projections?



The chart below takes EUR-DM crosses & looks at the spread between Qi’s “Interest Rate Differentials” factor (1y1y, 2y2y & 5y5y x-mkt yield spreads) & Qi’s “Growth Expectations Differential” (the shape of the 5s30s yield curve in each currency) factor.

As you’d expect most of the time that spread is positive – the default pattern is currencies trade off interest rate differentials. And the majority of crosses still show that default pattern today.

But EURSEK is a clear standout. The move deep into negative territory suggests the cross has become more sensitive to the relative economic fortunes of the EuroZone versus Sweden.

Maybe the Krona’s weakness reflects Sweden’s position as one of the G10 countries with the largest private sector debt levels & therefore most vulnerable to a housing shock.

Does it matter?

If more FX crosses start to see a shift in emphasis, investors need to re-think their approach. Fortunately, Qi captures these sensitivities every day & can alert you to such a regime change

#3. Dollar dictating risk assets – regional banks & EEM caution – they want a weaker dollar but also trading macro-rich

In an earlier note (“The Dollar Juggernaut”, 24th April), Qi stated the importance of the Dollar was increasing for risky assets – the negative sensitivity of the Dollar to SPY is high relative to history and high relative to the importance of other macro factors. See the first chart below showing the inverse relationship between SPY and the dollar over the last month. Tactically, note that dollar has yet to breach 3rd May lows while risky assets have made headway since – orange signal?

We highlighted in that note the winners & losers from the scenario of a stronger dollar. If the dollar remains on the backfoot, the winners would be Asia Pac, Growth (Tech / BioTech) and domestic-geared sectors (retail, real estate, banks).

However, we would highlight KRE and EEM as two weaker Dollar beneficiaries that are trading rich to the Qi model at 0.75 sigma and 0.93 sigma, respectively. Optimism looks over-extended. Below see EEM – the FVG is in fact the highest since Jan-23. Since 2009, selling EEM at +0.9 sigma has yielded a 65% win rate across 20 trades.

#4. Macro + Politics. USDZAR

If the strong Dollar is to prompt a pause in recent Emerging Market outperformance, is there an FX angle?

The cheapest Dollar-EM cross on Qi is USDZAR. It is 1.6 sigma or 2.3% cheap versus macro-warranted fair value. The caveat is model confidence is only 25% but, as the chart below shows, Qi’s FVG has done an effective job recently at calling local turning points.

Moreover, one potential explanation for low model confidence is the upcoming South African election. A case of politics outweighing macro conditions.

If true, then at these levels the onus is on a decisive & market-friendly result from the general election. Absent that, the risk-reward for the Rand is not great in either political or macro terms.

#5. Trading inflation tails ahead of CPI

With market focus on FCIs as opposed to growth expectations, next week’s CPI print will likely be pivotal to determine near-term market direction. With this in mind, we show the winners vs. losers on a hotter or softer than expected reading.

We have screened on the basis of both sensitivity to inflation expectations and Qi fair value gap. On a soft print, the winners would be speculative tech, SPY vs. FXI. Likely also domestic interest rate sensitive sectors e.g. KRE, S5REAL, as well in part bond proxies like Utilities. On a hot print, winners would be commodity equities and fuelling China's equity strength.

Qi is showing that the weak Yen is no longer a positive for the Nikkei – global investor reluctance appears to be rising as JPY weakens.

Some commentators have argued we are now in a secular bull market for Japan, similar to 1960s into early 70s when Japan strongly outperformed the rest of the world. This case is made on the basis of geopolitics - Japan is fast becoming the high-tech production hub for the Western hemisphere; political pressure to create demand-driven inflation; an acceleration in corporate reforms. A byproduct of this has been a weakening JPY which has been encouraging greater inbound tourism also.

Over the last 1yr, the Nikkei has returned 31.5% in local currency terms (vs. 30% for the Nasdaq), setting a new ATH. In USD terms, performance has been more disappointing – in fact, YTD the Nikkei” has underperformed SPX by ~ 4% in USD terms. On Qi the weak Yen/ strong Nikkei relationship is also waning:

Qi macro-warranted fair value for USDJPY, is struggling to get past 154-155. However, this is not a core tenet of the Nikkei thesis.

While the sensitivity to USDJPY , is still negative, Japan GDP Nowcast, DM economic confidence (proxied by tightening peripheral European govt bond spreads), copper and falling rate vol have been dominant drivers of Qi model value over the last 2mths. Nikkei strength does require a reflationary narrative.

This has left investors with the question of whether the current dip is seen as a buying opportunity. At the global index level, the Nikkei is the global value play using Qi’s framework. It is currently the cheapest index globally on Qi’s framework. The Nikkei is trading at -1.2 sigma (-10%) to Qi’s LT model value. That gap is particularly large vs. history, especially as macro confidence starts to rise from the decline over Q4 2023

Qi sees this value also on an RV basis – BOTH in local currency and USD common currency terms. A key driver of this value of later has been the higher sensitivity of SPY to US FCI / wider credit spreads. It has been noted that several global indices have been outperforming the US, even the almighty Nasdaq (in LC terms) – the FSTE A50, Nikkei, Euro Stoxx 50 etc. Europe, Japan, China are all seen a reflationary, value plays if we are remain in a world where growth remains robust but where the US potentially has a stickier inflation outlook.

Qi sees this value also on an RV basis – BOTH in local currency and USD common currency terms. A key driver of this value of later has been the higher sensitivity of SPY to US FCI / wider credit spreads. It has been noted that several global indices have been outperforming the US, even the almighty Nasdaq (in LC terms) – the FSTE A50, Nikkei, Euro Stoxx 50 etc. Europe, Japan, China are all seen a reflationary, value plays if we are remain in a world where growth remains robust but where the US potentially has a stickier inflation outlook.

Qi sees this value also on an RV basis – BOTH in local currency and USD common currency terms. A key driver of this value of later has been the higher sensitivity of SPY to US FCI / wider credit spreads. It has been noted that several global indices have been outperforming the US, even the almighty Nasdaq (in LC terms) – the FSTE A50, Nikkei, Euro Stoxx 50 etc. Europe, Japan, China are all seen a reflationary, value plays if we are remain in a world where growth remains robust but where the US potentially has a stickier inflation outlook.

1. Attributing the pullback to macro – financial conditions and risk aversion are front & centre

The S&P500 index has fallen x.x% from its local peak on 28th March. Qi's macro return attribution model is able to reveal the macro components of the drawdown thus far - important for any risk manager to understand as cross-asset vol rises, alongside any traditional style / industry exposure analysis.

Through a macro lens, the largest drags have come from risk aversion and financial conditions. Risk aversion is proxied by VIX; while the primary drag within financial conditions comes from wider HY credit spreads, dollar strength and higher Fed QT expectations (i.e. rate vol). The pullback thus far has NOT been about growth concerns - indeed, in aggregate the component of returns from our growth expectations bucket has been positive. Specific returns are the residual of returns that cannot be explained by macro - this component is also positive. In other words.

2. The S&P500 Macro Beta Impulse is also starting to rise led by sensitivity to real yields and the dollar

Had apathy grown about the ability of equities to rally regardless of the news?

We have said in several recent reports that risky asset vulnerability would be reflected in
1) Falling model price momentum and
2) A rising macro beta impulse. Both of those boxes are now ticked.

Further, we are seeing signs that financial conditions are starting to matter – it is not merely about the growth outlook.

We had previously commentated that in Q1 the S&P500 sensitivity to real yields almost turned positive – a reflationary mindset.
That is now changing into Q2 where we see the sensitivity to real yields turning more negative – a sign of market nervousness.

3. All eyes on Janet Yellen

Her "serious concerns" comment effectively gives the Japanese a green light to intervene in USDJPY. She is also in charge of the Quarterly Refunding Announcement due in 2 weeks time.

Aside from earnings season, these are arguably the two most important bits of event risk facing markets today. The preferred scenario for risky asset bulls is:
1.) MoF intervention - it has marked the top in the Dollar & US yields on the previous two occasions they've stepped in
2.) a repeat of November's QRA that skewed US debt issuance from bonds to bills &, alongside the Fed pivot, was the catalyst for the "everything rally" over the last 5 months.

If that transpires, FX players will be back seeking strategies that work in a low vol, high carry environment. On Qi, USDMXN looks the most interesting for believers in a Dollar reversal.

It's been 0.8 sigma (1.9%) rich to macro & in regime just 8x since 2009. Back-testing that FVG as a sell signal elicits a 63% hit rate & +1.5% average return. Over the last year Qi's FVG & spot price have posted a strong correlation suggesting there's good risk-reward on the current gap closing the 'right' way.

4. SANOFI – Cheap with Interesting Macro Exposure Characteristics for Portfolio Construction

• Sanofi is cheap to the Qi macro warranted model price by 1.2 standard deviations or 8.4%
• This is close to the cheapest it’s been in the last year on macro model valuation while macro has been significant in terms of explanatory power of share price
• The drivers are also interesting for portfolio construction purposes as they are fairly opposite to the SXXP index, Sanofi wants

1. Higher inflation
2. Higher real rates/credit spreads
3. Lower GDP and a flatter curve

• Stock was hit in Q4 last year owing to concerns about further R&D spend and Q124 earnings are out next week

5. Market breadth stifled - US Technology model momentum now waning, led by the more speculative end i.e. ARKK

In a sticky inflation world, the improvement in S&P500 breadth is now stifled and folk will try to hide in quality, mega cap tech over small caps and bond proxies. However, this isn’t really a great recipe for a risk-on market. For breadth, we need speculative areas to outperform. See the first chart.

We track Qi model price momentum across all securities. Zooming in on our universe of 179 equity ETFs, we note that only 25% of this subset have seen their macro warranted model value rise over the last 4wks. See the second chart below. Digging further into where macro momentum has been weakest, we see the more speculative end of Technology as the biggest laggards e.g. ARK Innovation, Biotech, ARK Next Generation Internet, Global Autonomous and Electric Vehicles etc. Indeed, these pockets are the most sensitive to financial conditions.

Qi has constructed a measure of the US credit impulse which speaks to financial conditions relative to trend. Be aware that credit has now turned a net headwind for markets / the economy. See the third chart.

6. Across commodity equities, energy still cheap to macro model value but precious / base metal equities still rich

In the scenario of a Fed policy error actually manifesting, the dollar would ultimately succumb to weakness. The equity market destination would be commodity sensitive equities, in the desire to increase exposure to real assets.

However, there is a distinction to be made within commodity equities. Recently, we highlighted GDX as a sell idea – dislocating from higher real yields and dollar strength. While GDX has started to weaken, it is still 1.7 sigma rich to Qi’s macro-warranted fair value. Alongside, COPX (Global Copper Miners) is still 0.6 sigma rich (first chart below). Copper itself is particularly sensitive to financial conditions, namely rate vol and CDX HY. Copper is 2 sigma rich to its Qi macro-warranted fair value.

The flipside is that US Energy equities trade cheap to their Qi model value and at the cheaper end compared to its US sector peers. Particularly, on an RV basis to US Financials (see the second chart below).