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1. The “bad news is good news” tightrope – lower bond yields but slowdown evident leading to waning market breadth

Qi’s SPY short term model has exhibited a high and stable macro explanatory power over the last 2 months at ~77%. The most important upside macro drivers are in order: trade weighted dollar (weaker); real rates (lower); credit spreads (tighter); inflation expectations (lower). See the chart below over the last month.

However, SPY model value momentum has stalled over the last 3 weeks. This period has coincided with the fall in copper, Atlanta GDP Nowcast and a pick up in risk aversion, rate vol and inflation expectations. Qi’s model recognizes these drags to the model value over this period – see the chart below. Softer growth has been one of the largest drags to model value.

Under the hood of the index, a “slowdown” rotation is more evident. We have seen a dislocation emerge through May where the index level has held up but Qi’s L/S US growth tracking basket has not. See the chart below. Over the last month, secular AI / electricity demand themes have propelled Tech and Utilities. This leave us nervous as the % of S&P500 stocks now above their 50d MA had hit a high of 85% at the start of the quarter but now only 48%

2. Screening Qi for stocks most / least exposed to a US slowdown

Qi’s framework allows us to quickly screen for stocks most / least exposed to a US slowdown. We screened for the top 20 most / least sensitive US and European names. See the two charts below showing equal-weighted performance of these names.

The longs in the US reflect high exposure to Financials. The short reflect names more sensitive to financial conditions than directly US growth. For both regions, we show the names selected by Qi below.

3. Crude vs. Inflation. Hard vs. Soft data.

In bonds, the fall in US Treasury yields over Monday & Tuesday was the biggest 2 day drop in 2024. The main drivers of the slowdown story are weak survey data & falling commodity prices, especially crude oil.

The chart shows US inflation expectations (using CPI swaps) & energy (WTI) in z-score terms. The latest sell off in crude markets has taken WTI 1.2 sigma below trend. Inflation expectations have sold off but not to the same degree; they remain slightly above trend.

Such disconnects are rare, which begs an important question.

Is the sell-off in crude a function of aggressive CTA selling rather than reflecting weak global demand? Or are inflation expectations simply lagging, & break-evens / nominal yields will ‘catch down’.

Put another way, WTI reflects the soft survey data once again sparking fears of an economy coming in to land. The correction in inflation expectations is consistent with the hard economic data, which is softening but yet to panic.
Cue Payrolls.

4. India or China?

For some, the Indian election result doesn't change anything. The long-term structural bull case remains intact.

It just requires a rotation at the sector level - away from infrastructure or renewable energy plays, & more towards consumer staples as realpolitik dictates Modi focuses more on rural, low income cohorts. But for others, there may be a broader, country level asset allocation decision. There is no doubt that, amongst global allocators, China's loss has been India's gain.

India's star has risen not just because of the domestic story, but because capital had fled Chinese equities during the Covid lockdown hangover.

Quant Insight's model of Chinese versus Indian equities (using the ratio of FXI / INDA ETFs), shows that overall macro conditions supported Indian outperformance over the last 4yrs.

Until now.

It may yet be a simple pause that refreshes, but the blue line below is showing signs of potentially carving out a bottom.

That means the entire macro complex - economic fundamentals, financial conditions, risk appetite - have moved from supporting INDA to becoming more two way.

If the blue line starts making new highs, the macro environment will start to become a tailwind for FXI outperformance instead.

We're not there yet. But, given the recent momentum in China & the Indian election result, it's worth monitoring closely.

5. NOK & the perils of two-factor correlation

Last week Qi flagged EURNOK looked oversold relative to prevailing macro conditions. The cross has rallied around 1.0% since then, & Qi’s FVG has narrowed from -1.3 sigma to -0.5. This week USDNOK looks interesting.

More specifically, how does this petro-currency pair trade with crude oil? Recent patterns show the Dollar is the bigger beneficiary from rising energy prices so this latest fall in crude will have many looking at simplistic WTI/USDNOK overlay charts & thinking about potential downside for the $.

Qi looks at the entire macro complex & while lower WTI prices are a drag, there are offsets (low risk aversion, tight credit spreads, falling UST yields) keeping model value flat-lining. Right now Qi says USDNOK “should” trade at 10.75 given the overall macro picture. That leaves spot 0.6 sigma (1.5%) cheap to model.

Our model is not in regime, but confidence is 60% & rising. Furthermore, our FVG has done a good job of marking recent highs & lows in spot USDNOK. Ignore the siren calls of chart crime. Absent an even bigger puke in crude plus broad “risk off” and a back-up in UST yields, the risk-reward does not look good here for USDNOK shorts.

6. FOX

FOX Corp is trading at 2.3 standard deviations rich to Qi macro warranted fair value, which is the 100th percentile over the last year

The stock has been driven up partly by good news on its new streaming service Tubi.

Qi drivers for FOX are inflation (positive to higher inflation), risk aversion (negative to increasing risk) and GDP (negative to higher GDP)

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.