Macro and Flows Update: November 2024 -e34

Summary

This video discusses the current state of the market following the November election, focusing on post-election relief, a steep rally, and potential pullbacks. The speaker emphasizes that while volatility compression at the index level is expected, significant sector rotations, particularly in small-cap stocks, will occur. Risks around inflation, bond yields, and AI sector earnings are highlighted, especially with Nvidia. The recommended strategy is to use calendar call spreads, capturing volatility decay while preparing for more volatility in early 2024. Overall, the outlook suggests ongoing market adjustments, but with potential opportunities for those navigating the evolving landscape.

Takeaways

• 😀 The market is experiencing a relief rally post-election, largely driven by the reduction in election-related uncertainty.
• 😀 Despite the strong rally, the market is currently overbought, with expectations of some digestion and pullback in the short term.
• 😀 The period after election results typically sees a weaker two-week cycle, but with upcoming holidays, the market is likely to see increased buying as time decay accelerates.
• 😀 The rally in the market is expected to continue, with higher volatility in early next year as investors focus on December's skew and potential reinvestment flows.
• 😀 The market will likely experience significant rotations, with certain sectors seeing strong performance while others may underperform due to macroeconomic shifts.
• 😀 The VIX is expected to remain subdued in the short term, though specific sectors and stocks could experience greater volatility.
• 😀 The Russell 2000 index is expected to continue its upside through the end of the year, with potential for strong performance in small-cap value stocks.
• 😀 AI stocks, particularly Nvidia, are at risk of a pullback due to elevated expectations and potential disappointments from earnings reports, with a focus on November 20th as a key date.
• 😀 There is a risk of a sector rotation away from tech and AI stocks into more inflation-sensitive sectors, such as small-cap and value stocks.
• 😀 The Fed faces challenges with managing long-term inflation and interest rates, with the potential for higher yields on the 10-year Treasury pushing up to 4.75% or 5% by early next year.
• 😀 Despite these concerns, buying calendar call spreads continues to be a preferred strategy, with the expectation of a grinding market rally and low volatility in the short term, but with an eye toward higher volatility in early next year.

Q & A

What is the current sentiment in the market following the election?

The market sentiment is shaped by relief following the election, but there are lingering uncertainties. While macroeconomic factors matter, the immediate market movement is heavily influenced by the post-election dynamics, with some bullishness but also concerns over market pullbacks after a steep rally.

What is the recommended strategy for the market given the recent rally?

The strategy is to treat any pullbacks as buying opportunities. Despite the recent rally, the expectation is that a 'dip-buying' approach will be effective, especially as the market enters the traditionally weaker November and December period.

Why is volatility expected to remain low despite market fluctuations?

Volatility is expected to remain low because the VIX (volatility index) is compressed at the index level, meaning overall market volatility is subdued. However, there will still be sector-specific volatility, especially in individual stocks or industries, which could lead to rotations in the market.

What are calendar call spreads and why are they recommended in the current market environment?

Calendar call spreads involve buying longer-dated call options while selling shorter-dated call options. This strategy is recommended because it allows investors to capitalize on the time decay of short-term options while benefiting from the potential for upward movement in the longer-term options. In the current market, where volatility is low but sector-specific movements are expected, this strategy is seen as effective.

What role does the Federal Reserve's actions play in the current market outlook?

The Federal Reserve's control over the short end of the yield curve has been supporting market stability. However, there is growing concern that if long-term yields rise significantly, the Fed may lose control of the yield curve, which could have negative implications for the market, especially if inflation pressures persist.

What is the risk of long-term interest rates rising to 4.75% or higher?

If long-term interest rates rise to 4.75% or higher, it could signal that the Fed is losing control of the long end of the yield curve. This could lead to higher borrowing costs, tighter financial conditions, and potential market volatility, which would be a significant risk for the broader economy.

What is expected to happen to AI stocks in the near future?

AI stocks, particularly those like Nvidia, are at risk of experiencing weakness, especially if earnings reports, such as Nvidia's in late November, come in below expectations. If there is any disappointment, it could lead to a rotation out of AI stocks into other sectors, like small-cap value stocks or inflationary trades.

How does the market typically behave during a 'V' compression period?

During a 'V' compression period, the market experiences lower volatility, and the S&P 500 may show a relatively placid performance. However, this typically leads to sector rotations, with correlations breaking down at the index level as individual stocks or sectors move in different directions.

What are some potential risks associated with political factors like Trump and Biden’s narratives?

Political factors, such as Trump’s involvement in policy decisions or the narratives surrounding both Trump and Biden, can drive market sentiment and volatility. These factors can lead to market swings, especially as issues like tariffs, immigration, and inflationary policies come into play, creating structural and cyclical risks in the market.

Why should investors focus on small-cap stocks and inflation-related trades as the year ends?

Small-cap stocks and inflation-related trades, like those in the Russell 2000, are expected to benefit from the market dynamics at the end of the year. As sectors like AI may experience volatility, small-cap stocks and inflation-sensitive plays may offer better opportunities for gains in the current market environment.