Go long the dollar, Treasuries and defensive stocks. Sell metals and the pound. It was an investing playbook that worked virtually all year — until suddenly it didn’t.
For a second straight day, 2019’s biggest winners across assets are getting hammered as investors reassessed expectations for global economic growth. The Treasury market set the tone, with a 10-month rally grinding to a halt Friday after data on the American consumer and labor market signaled a recession is far from imminent.
Yields jumped, spurring the worst momentum unwind in U.S. equities this decade on Monday. Stocks coveted for their defensive characteristics — REITs and utilities — got pummeled at the expense of banks beaten down during the Treasury rally. Oil, battered by signs of flagging global demand, surged back toward recent highs. Copper rallied, and the dollar pulled back.
While none of this week’s moves send an all-clear on growth concerns that gripped markets for most of the summer, the violence of the reversals reminded investors just how quickly things can change. Nomura cross-asset strategist Charlie McElligott says the swiftness reflects repositioning by trend-following funds known as commodity trading advisers. Their strategies peaked last week when the 10-year Treasury yield sank to a nine-year low before spiking more than 20 basis points.
Economic data “caught a U.S. rates market ‘priced for the end of the world’ somewhat flat-footed,” McElligott wrote. CTAs, which have billions pegged to their bets, likely were forced to unwind their positions, contributing to the magnitude of the market moves, he said.
“This to me reiterates just how much of this rates rally in recent months has been from mechanical sources like ‘price-based momentum’ (i.e. CTAs) and ‘convexity-hedger-‘ flows,’’ he said.
Trend-following strategies often come in for criticism during times of market tumult, called out for exacerbating moves to the downside after contributing to steep advances. The last major shock was almost a year ago, when Jerome Powell sparked fears the Federal Reserve would tighten too aggressively, sending high-flying technology shares tumbling.
This week’s reversal has the distinction of being distinctly cross-asset, with turns on display in currencies and commodities where investors had positioned themselves for a further downturn in the economic outlook.
JPMorgan’s index of developing-market currencies jumped from its lowest level in data that goes back to 2010, and the Bloomberg Dollar Spot Index has rolled over even as December 2020 federal funds futures have taken half a cut out of implied pricing relative to a week ago. Copper, a commodity celebrated for the signal it sends about global activity, has also rebounded.
It’s tough to blame CTAs for the rotations under the hood of the U.S. market, given that they trade futures rather than single stocks. But those swings also fit the theme of an abrupt end to successful, and in some cases, popular, trades.
The outperformance of software and low volatility relative to the S&P 500 has ceased; global stocks and U.S. small caps have started to outperform the U.S. equity benchmark gauge.
“Extreme positioning is contributing to the factor reversal,” writes Evercore ISI head of portfolio strategy Dennis DeBusschere. “Based on the latest 13f data, active managers have taken their underweight in Traditional Value to a new all-time low while boosting exposure to Expected Growth.”