“Winning isn’t everything, it’s the only thing.”
-Vince Lombardi
Many VCs will talk about toeing the line between 1) Some version of what we’ll call “repeat success” bias and 2) Independently non-consensus, but game-changing ideas.
Good ideas require execution, particularly when building companies from the ground-up. A huge amount of time is spent probing founders in the early-stage, private capital space.
Successful founders know what it takes to execute, but this success dynamic also creates an anchoring bias which extrapolates success from a new and potentially weak idea.
The brash title (and quote) above is somewhat tongue and cheek, because the probability of predicting repeat successes depends on the arena you’re playing in… Probing founders and CEOs is arguably more important in some arenas, but Anchoring and Recency Bias are major hurdles in every buy/sell arena.
Back to the Global Macro Grind…
We continue to ride the same sector and factor playbook for now in domestic equities while being weary of changes. We wrote about this asset allocation in a note Monday: Why is the Domestic Growth Style Factor Broadly Outperforming and Will it Be Sustained?
An important theme we will outline this morning is that while the winners of the last 12-18 months led the broader market after the brief crash to start February, it’s come behind higher relative volatility.
There are some wide divergences in FAANG performance YTD, but all of the major FAANG names are still outperforming the S&P 500 Index (SPY) and XLK is outperforming SPY by 608 basis points (bps):
SPY: +3.16%
XLK: +9.24%
FB: +4.38%
AMZN: 36.04%
AAPL: +5.44%
NFLX: +67.51%
GOOG: +9.85%
“Growth” at the factor and sector level continues to work.
If we look underneath the hood at some of the market internals for something like the S&P 500, the FAANG names continue to be a source of strength, but also risk, which is why we have followed the relationship of realized and implied volatility so intently in our long-standing core exposures like Information Technology (XLK) and Russell 1000 Growth (IWF).
Any equity manager with a large-cap benchmark is likely forced to care on these names which is why hedging markets reveal so much color on sentiment. Consider this:
- SPY total return is 3.16% YTD
- The 5 FAANG names collectively have a ~12% weighting in SPY as of yesterday’s close
- Cap-Weighted total return from that 12% contributes 197bps of that 316bps YTD return for SPY
- Therefore over 62% of SPY YTD returns comes from 5 companies. There may be different preferences of these market internals but the conclusions are hard to ignore the way we looked at it.
So again, FAANG names are contributing to both performance and broader index volatility. Breaking apart volatility trends at the capitalization level, we know growth is outperforming value across the cap-spectrum which is independent of FAANG:
Relative YTD Performance for “growth” over “value” factor ETFs in Russell indices:
- R1K: +641bps
- RMid: +645bps
- R2K: +622bps
However, Large-Cap has been much more volatile than small-cap indices on both a realized and implied basis – the wide divergence is new this year. Below we outline historical realized volatility percentile readings for the Russell indices with the complementary implied volatility percentile readings in parentheses:
- R1K (IWB): 61% (41%)
- R-Mid (IWR): 47% (31%)
- R2K (IWM): 35% (11%!)
In a round-about way we get to a discussion on interest rate volatility expectations which was a source of wide volatility discounts in the financials sector (XLF) heading into February (called “implied dispersion” vs SPY benchmark). This is still the case, despite the fact that long-term rates are basically flat m/m. Essentially, forward-looking volatility expectations compressed significantly in financials (XLF) vs. market (SPY) and muted rate volatility continues to support this dispersion:
- Whereas Russell 2000 60-Day realized and implied volatility trades at 4 point and 6 point premiums to Russell 1000 index volatility historically, the two are currently priced the same which is an anomaly, and it’s likely driven by rate expectations.
Here are industry weightings for the following ETFs:
- IWB (internet, software, computers): 20%
- IWM (banks, REITs top 2): 19%
- IWN (banks, REITs top 2): 29%
As we show below in the Chart of the Day, a ratio series of the S&P 500 volatility index (VIX) relative to the Russell 2000 volatility index (RVX) is at 5 and 10yr highs with large-cap growth volatility and rates-rising biases having been suffocated over the last month.
The winners continue to win, but in 2018 it’s volatility management that has been a curveball. We continue to ride the same exposures while more intensively monitoring underlying internals and potential phase transitions.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.80-2.91% (bullish)
SPX 2 (bullish)
VIX 14.18-21.16 (bullish)
RUT 1 (bullish)
NASDAQ 7130-7645 (bullish)
Nikkei 203 (bearish)
DAX 112 (bearish)
USD 89.41-90.29 (neutral)
EUR/USD 1.21-1.24 (neutral)
YEN 105.50-107.43 (bullish)
GBP/USD 1.37-1.40 (bullish)
Oil (WTI) 59.74-62.99 (bullish)
Nat Gas 2.62-2.86 (bearish)
Gold 1 (bullish)
Copper 3.07-3.17 (bearish)
Good luck out there today,
Ben Ryan
Macro Analyst
