When Secular Trends Reverse

By Charlie Bilello

19 Jan 2021

The most significant investing trends over the last 10 years can be summarized as follows…

  1. Large Caps over Small Caps.
  2. US over International.
  3. Growth over Value.
  4. Tech over Everything.
  5. Long Duration over Short Duration (Yields Falling, Curve Flattening).
  6. Stocks over Commodities.

When Covid-19 first hit the US last February and March, all of these pre-existing trends accelerated.

And that made perfect sense.

The narrative: a global Depression was coming, and during a Depression a) large companies were more likely to survive than smaller companies, b) the US should fare better than the rest of the world given the enormous monetary/fiscal stimulus, c) growth companies would be bid up in a world starved for it, d) technology would thrive as people were forced to stay at home, e) bond yields would plummet as deflationary pressures took hold, and f) commodities would crash from the lack of demand.

These narratives seemed inevitable, and prices were confirming.

But then, with no advance warning, a strange thing started happening. One by one, these trends began to reverse course…

1. Yield Curve and Duration Reversal

The forward-looking bond market was the first to change directions. After inverting in August 2019, the Yield Curve would flatten aggressively during the covid-19 crash, but never exceed its 2019 low. It bottomed in February of last year and began to steepen as short-term rates remained low (on Fed’s promise to hold off on rate hikes for a few years) while longer-term rates moved higher.

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The 40-year downtrend in long bond yields (30-Year Treasury) culminated in a close below 1% in early March. Since then it has trended higher…

The underpinning of the move higher in yield was an unexpected shift in the inflation outlook. The deflation that many assumed was a given never occurred, and after a vertical ascent inflation expectations are now at their highest levels since 2018.

With long-term yields and inflation on the rise, the ratio of short to long duration bottomed last August and began to reverse course.

2. Size Reversal

The ratio of Small Caps to Large Caps would bottom about a month after the Yield Curve reversal and a few days before equity market low.

With the news of the vaccines and subsequent stimulus bills, the ratio has since exploded to the upside.

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3. Commodity Reversal

Commodities were in a long-term downtrend relative to stocks well before covid-19 hit. But with the worldwide lockdowns, demand collapsed like never before. Crude Oil futures actually turned negative in April, a remarkable event no one thought could ever happen.

But since then, the ratio of Commodities to Stocks has not hit a new low.

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And with Crude Oil now back above $50 a barrel, talk of “reflation” has begun…

4. Geography Reversal

The next trend to change course was the dominance of US stocks, with Emerging Markets showing relative strength starting in May followed by international stocks more broadly in September.

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Supporting this change in leadership was a trend reversal in the US Dollar, which peaked in March and started moving sharply lower…

5. Style Reversal

“Value is dead.”

Not since 2000 have value investors faced a more challenging period, with a significant underperformance relative to growth for the last 14 years.

This trend reversed course last September with value stocks taking the lead.

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6. Sector Reversal

The last trend to reverse was the most powerful story of all. Technology stocks had benefitted from the pandemic like no other sector, and their outperformance following the lockdowns was stunning.

But since last September, Tech stocks have actually underperformed the broad market, a potential change in trend that few investors envisioned and fewer still are prepared for.

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When secular trends reverse, no bell is rung, and no one can believe that a shift has actually occurred.

But as narratives follow prices, the longer they are sustained, the more the story changes and the more people believe it.

That has already begun, with the current narrative of a Depression averted, with a) small companies benefitting more from stimulus measures than their larger counterparts, b) global stocks benefitting from a falling dollar and higher global growth, c) value stocks improving with the rise of interest rates and the steepening yield curve, d) technology underperforming as the vaccines and herd immunity will allow people to leave their homes again, e) bond yields rising with inflation pressures mounting, and f) commodities moving higher with a resumption of growth and demand.

When covid-19 first hit, all of these narratives would have seemed absurd. And yet here we are. Where the story turns next remains unknown, but the fact that we’re even entertaining these secular shifts is remarkable, and more proof that the only sure thing in markets is that they are full of surprises.


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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.

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