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The S&P500’s Qi factor sensitivity to growth (GDP Nowcast, copper) and financial conditions (Fed QT expectations, HY credit spreads) to SPX stands at 1yr highs. Equities are increasingly reliant on what we saw late last year to continue. This picture is similar for other major indices. The Nasdaq 100 sensitivity to HY credit spreads and economic growth is also both at 1yrs highs – the two biggest drivers of the index.

The Qi S&P500 macro beta impulse is defined as the sum of the 4wk change in absolute sensitivities across all our macro factors, based on ST models. We plot that against the percentage deviation of the S&P500 from its 50d MA and invert that axis. See the chart below.

The premise is simple - as the gradient of macro factor sensitivities accelerates, the beta of the market to macro factors is rising. That is fine when the macro backdrop is moving in your favour but ordinarily Mr. Market struggles to digest the macro gyrations.

Note the dislocation that occurred over the most recent 8wk rally – the improving growth / inflation trade-off supported by the Fed “pivot” saw macro drivers move in favour of Qi’s models. The Beta Impulse rose but this time around S&P500 model price momentum was rising alongside this.

This backdrop creates vulnerability as the impulse rises ever further. Over the last few years, there appears to be a natural limit beyond which the beta impulse has peaked (ex-Covid). This is marked by the red line. Periods where have seen such as dislocation between price action and the beta impulse tend to re-converge, marked in the chart

Consider the Qi short term model of the S&P 500 – 93% model explanatory power and the model price starting to show signs of fatigue. We view model price as offering a true / less noisy representation of the market value than the spot price. Has the improvement in the growth / inflation trade-off already been priced?

In contrast, 2023 was about the improving growth / inflation trade-off aka Goldilocks, in the face of the naysayers calling for a hard landing after the fastest Fed tightening we had see in recent years.

During a disinflationary period, the fear of a late business cycle and the lagged impacts of policy is what matters for risk-off more than financial conditions. The S&P 500 in 2023 has an inverse relationship to its beta to growth relative to financial conditions. See the second chart below.

This should not surprise. If the economic backdrop was benign, investors will not be worried about growth i.e. sensitivities will remain relatively muted. When growth fears rise, the beta to growth will rise relative to other factors.

Today, under the hood, since early December the beta to growth has started to rise relative to financial conditions – how much tighter do we really expect credit spreads to get from here? In other words, the second chart suggests equities look rich relative to the growth / inflation trade-off – a similar level of confidence was also seen in late July. The bar is set high. Thus we would argue the market is trading on hope rather than fear into 2024.

Next year, the outlook is more poised on a knife-edge in our view. Street strategists simply extrapolate the last 3mth price action into their annual outlooks. The length of the runway for stocks will be dictated again by the growth / inflation trade-off and Qi offers the tools to expose this.

Qi's model for IGV has 79% confidence. This latest regime started at the beginning of May and confidence has been pretty stable since then.

On current patterns, the Software sector is dominated by a desire for reflation, rate volatility to remain contained and credit spreads to tighten. Software loves Goldilocks.

The Fair Value Gap is +1.1 standard deviations which currently translates into IGV standing 7.8% rich to overall macro conditions. In short, and from a pure macro perspective, a fair amount of good news is in the price.

The chart above shows IGV relative to semiconductors. The white line is the spot price of the IGV/SOXX ratio; the red line is Qi's macro-warranted model value for the pair. 

Once again IGV wants reflation. Higher inflation expectations are consistent with Software outperforming Semis. The recent fall in inflation expectations are the biggest reason for the 3% fall in Qi model value over the last month.

That decline in model fair value stands in sharp contrast to the recent spate of IGV outperformance. Hence a 8.7% rich valuation on Qi.

And finally we show Software versus the broader market by modelling the IGV/SPY ratio.

The desire for reflation is there again but this time other factors have worked to offset the drag from falling inflation expectations. The net result is macro momentum has eeked out a 0.9% gain on the month. 

And once again, the recent rally in IGV has outstripped where aggregate macro conditions say it 'should' trade. Software screens as 6.5% rich relative to the S&P500 on Qi.

This is not to dispute the idea that the second wave of the AI revolution could provide a huge benefit to software stocks. The AI theme is not going away in 2024.

It is a warning that, should the mood of the market turn down, then IGV looks vulnerable from a tactical perspective. More specifically any scenario that speaks to sticky inflation, rising bond vol and wider credit spreads poses a risk.

Even bottom-up or thematic investors should know that, with Payrolls on Friday and the Fed meeting next Wednesday, the macro angle needs to be factored in.

But the Euro has quietly rallied almost 2% in October. That would appear to contradict the narrative about comparatively weak European growth. It's also taken place against a backdrop of US nominal yields moving higher than their European equivalent.

So what is driving things?

When we look at Qi model value for EURUSD we can see it bottomed at 1.0463 on Oct 19th and has subsequently bounced almost two big figures.

The biggest driver of that move?

Partly that the initial "risk off" move - credit spreads and China stress - hasn't gotten any worse. But the main push behind macro model value has come from relative inflation expectations.

The chart below shows the difference in European and US 5y inflation expectations in z-score terms. EU inflation expectations are now almost 2 standard deviations below trend versus their US equivalent.

The market is starting to price a hard landing in Europe.

Now at some point that disinflationary scenario will probably become a headwind for the Euro. Similarly a renewed surge in US nominal yields or credit spreads legging wider both have the power to shift macro momentum once again.


But the recent pattern suggests real yields have mattered more and are currently favouring higher EURUSD.

There is no valuation edge - spot is trading in line with macro conditions - but a good example of how important it is to understand exactly what it is driving markets.