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Improvements in the vaccination programme, increased mobility & the fact that it has lagged the US, are all cited as reasons why Europe benefits from the next wave of the reflation trade.

Qi’s European Technology vs Financials model is in regime (76% model confidence) with an intuitive set of drivers. The European Technology sector may be smaller than its US equivalent but it shares the same defensive characteristics. Falling inflation, declining commodities & wider credit spreads are all consistent with tech outperforming banks.

But at +1.3 sigma (+4.3%) the Fair Value Gap for the SX8P / SXFP ratio is getting towards the top end of recent ranges, suggesting a fair degree of that news is in the price.

Back-testing the significance of the +1.3 sigma FVG as a sell signal since 2009 produces a decent hit rate (63%), a negative average return but positive median return of +1.1%. There is a fat-tail of outsized losses that skew the results. Adding a discretionary overlay & incorporating stop/losses alongside the Qi valuation signal is critical.

Still, as a trade expression for a European re-opening, this merits consideration.

Moreover, there are a few other red flags appearing across Qi’s multi-asset universe.

Macro’s explanatory power has started to fall across a number of US equity sectors. The blue line in the chart below is the model confidence number for each of the eleven GICS Level 1 sectors aggregated together. History provides a few instances where falls in model confidence at the sector level has pre-empted a fall in macro explanatory power at the broader S&P500 index level.

Then we have some traditional cyclical sectors throwing up some notes of caution too. RETINA™ shows US Energy sectors OIH & XOP (chart below) as slightly rich on macro valuations & now entering a new downtrend. US Homebuilders XHB has also just seen a RETINA™ momentum sell signal with the uptrend now in overbought territory & decelerating.

Moreover, it is not only a US phenomenon. European Autos display the same profile - close to macro model value but on the cusp on moving into a new downtrend. The LT trend looks overbought & momentum appears to be rolling over.

Indeed, RETINA™ is generating a broad array of momentum sell signals. That includes several EM fx crosses including MXN, BRL & ZAR. Plus two key equity index futures – the Dow & DAX.

These are all momentum rather than valuation signals. A combination of waning momentum plus rich valuation would provide a stronger signal. However, in conjunction with our Vol Indicator & signs of macro explanatory power slipping in key areas, there are an increasing number of warning signs for risk appetite.

The rotation trade that has dominated equity markets has been undergoing a consolidation for the last month. For many, this is a pause before the primary trend re-establishes itself. The second phase of the reflation trade could be more discerning than a simple growth versus value dynamic though.

Divergence between winners & losers could take a different shape. Pricing power is one variable that could be key. Which stocks have the ability to pass higher raw material costs onto the consumer in the form of higher prices?

Bottom-up analysis will provide one answer. It is worth overlaying that with the quantitative top down picture. The chart above shows the eleven GICS Level 1 US sectors & their sensitivity to US inflation expectations.

Should any of these relationships turn negative, we would have an empirical demonstration that rising inflation had flipped from being a tailwind to a headwind for that sector.

One vehicle for trading the climate theme is the Invesco Solar ETF. TAN is now one sigma (28%) cheap versus macro fair value on Qi’s model which has a strong (75%) confidence. That FVG has opened up because of a sharp divergence between a stable macro fair value (red line) & sharp fall in the spot price (blue line).

The model is dominated by two critical drivers. A desire for stronger global growth & ongoing Quantitative Easing from the Fed. In that sense, & in smart beta terms, it reflects elements of both a value play as well as growth. The growth to value rotation has driven some of the profit-taking that has hurt TAN of late, but Qi shows economic growth is a key positive macro driver.

For many, TAN captures two key contemporary themes – climate change, plus President Biden’s infrastructure plans which include a strong element of new environmental technology.

Given the secular shift to green tech, plus the potential cyclical kicker of the reflation trade being juiced by the American Jobs Plan (& assuming no offset from monetary policy), Qi's valuation makes TAN a potentially interesting vehicle.

Model confidence is strong (80%) & the drivers are intuitive. Industrials outperform in a reflationary, Goldilocks environment – rising inflation & commodity prices, easy financial conditions (especially tight credit spreads) & low risk aversion (VIX).

At this FVG, XLI vs. XLU has discounted a decent amount of bad news. For those who believe this is simply a pause that refreshes the reflation trade, this provides an attractive entry level.

Indeed, since 2009 buying the XLI/XLU ratio at -0.8 sigma FVG (subject to the model being in a macro regime) has produced 20 trades, a hit rate of 85% & an average return of +2.1%.

The one caveat is that macro model value has also edged lower in the last few days. Watching that via the Historical Model Value chart on the Qi portal will help finesse execution levels. The ideal combination is cheap valuation plus macro model value turning higher.

Qi’s analysis agrees – our model of 10y CNH interest rate swaps is in regime, shows yields as 1.3 sigma (14bp) too low & that global growth is the dominant driver. Such significant FVGs when in regime are rare. Since 2009 there have been only six occasions & the hit rate on pay signals in that time is 83%.

It is not only a China phenomenon. 10y Singapore swaps are also rich to model & if we broaden the search to all EM rates across all maturities, 5y SGD is notable. It is the richest point across all EM yield curves, & it has just triggered a Qi Divergence signal – the sharp fall in yields is in contrast to macro model value which has risen over the last 10 days.

Asset allocators wanting Asian interest rate exposure should instead consider Taiwan, Korea & Indonesia looking at Qi valuations across all points of the yield curve.

Mahmood Noorani , the founder and CEO, knew that he wanted something different. He wasn’t sure what it was, all he knew what that it had to be something that he hadn’t seen before.

And he isn’t afraid of new ideas. He was the one who approached Michael Hobson, Professor of Astrophyics at Cambridge and world-famous in his field, with the idea that they explore the financial markets together.
As a result, the "Look up™" brand was the strategic heart.


Mahmood Noorani, CEO, Quant Insight, said: “When astrophysics is applied to financial data, something extraordinary happens. You can see patterns where others often find confusion and you can make precise and accurate decisions instead of relying on ‘educated’ guesses.
"We needed a brand redesign that could capture and reflect the way we are pushing boundaries in the financial data world. Saboteur was able to see our vision and have translated our complex world into something eye-catching, brave and elegant. A brand redesign which is out of this world. It also brings clarity to a world which is overloaded and clouded with data."

Alex Clegg, The Dreaming Saboteur, said: “The financial sector is instinctively conservative. “Websites can look like they were designed in Excel – Quant Insight were clear from the beginning that they wanted their brand to be as different as the pioneering technology they’ve created.
“Elements float and drift in a seemingly random fashion. But, of course, there is pattern here. All you have to do is look up.”



About Quant insight
Quant insight provides global investors with unique insights and quantitative financial market analytics to help performance. Solutions are delivered through a range of products for easy implementation by investment managers, hedge funds, quant/systematic teams, portfolio managers and risk officers.


For further information, please contact:

Stephen Baldwin
sb@quant-insight.com

There is a surfeit of back-fitted narratives trying to align a story with price action. Instead Qi offers a 10y UST model that has a 95% degree of confidence & which currently shows yields as 0.5 sigma (16bp) low versus fair value. This latest move doesn’t look consistent with macro fundamentals.

Flows can dominate in the short term but the key macro drivers have strong explanatory power. Tight credit spreads & higher inflation expectations equate to higher yields & between them account for 30% of model confidence. Crude oil is, by some margin, the biggest single driver. Bond yields’ sensitivity to oil has risen sharply since early Feb.

Less obvious is the negative relationship with global economic growth; a pattern which emerged over March & runs counter to conventional thinking. It could reflect bond yields as a measure of US fiscal policy. Bad economic news results in a bigger fiscal response, & hence higher bond yields. Viewed in that light, the recent strong run of US data has reduced the likelihood of further fiscal stimulus, & thereby reduced the upward pressure on US yields.

Fitting a narrative to explain price action is inherently a subjective process. The quantitative pattern may not be immediately intuitive but is transparent, updated in real time & often the ‘explanation’ arrives after the fact.

From a macro perspective, that period of consolidation never saw a deterioration in fair value. Qi’s model value (red line) tracked sideways. The fall in spot price (white) took it to 0.5 sigma (6%) cheap to macro at the start of this month.

Now, after a bullish report from a US bulge bracket Investment Bank yesterday, spot is starting to rally once again.

Still, for believers in a copper super cycle, the metal still trades cheap to macro-warranted model value. 0.3 sigma is 3.4% below model.

Aside from green / EV dynamics, Dr Copper remains a global growth play. Global GDP growth accounts for nearly a third of model explanatory power. A model which has 90% confidence currently.

The Qi work on the shifting macro regime for momentum as a smart beta strategy can be found here