January 28th, 2022

Many people point to rising rates as the reason for the NASDAQ 100’s underperformance this year. But that is not what the data tells us. On January 28th, in our Intermarket Analysis note below, we highlighted that rising rates and a flattening yield curve create an environment that has historically led to a weakness for QQQ.

Déjà Vu?

Rates on the long end of the curve have lost speed relative to their shorter siblings, causing the curve to flatten as bond market participants are discounting lower growth in the future – an environment eerily like that of late 2018. This dynamic has historically been risk-off in both stock and bond markets, but opportunities could exist to attempt to take advantage of this environment.

The Federal Reserve was front and center this week, moving markets on the heels of their two-day meeting by coming off as more hawkish than investors were expecting. This clearly put a lot of eyeballs on interest rates. The 10-year yield has been working higher since August 2020 and is now at a critical level near 1.80%. The six-month slope of the 10-year yield is positive.

Perhaps more interesting is the fact that the yield curve is flattening. The six-month slope of the Two/Ten Spread has been below zero sine July 2021. Generally, the curve flattens when growth is slowing. While an inverted curve portends a recession. That is not the call that we are making, but we will note that the extreme long-end of the curve 20s and 30s has been inverted (see our daily notes where this has been discussed).

If I were an economist, my main question would be: “is the Fed about to tighten into a growth slowdown?”

Here, we are more concerned with what the current environment means for the markets. One market caught out attention and that is the Nasdaq 100. Investors generally get their exposure to this market through the Invesco QQQ Trust (QQQ).

We looked back to January 1, 2000, for instances where the six-month slope of the 10-year yield was positive while the six-moth slope of the two/ten curve was negative. There have been 1,002 days where this has been in the case. Over the next three month, the median return for QQQ has been -0.40% and it has been positive only 48.74% of the time. This compares to baseline three-month statistics of 4.15% and a 68.04% hit rate for QQQ over the same time.

When looked at relative to the S&P 500 SPDR ETF (SPY), QQQ sends to underperform over three months while these dynamics are in play. Median underperformance is 90 bps and QQQ lags SPY 54.83% of the time.

Rising rates have been trotted out as the reason for weakness in the Nasdaq 100 over the past month. But that only explains part of the situation. In fact, when we isolate for rising rates alone, QQQ has historically outperformed SPY over the following three months by 88 bps (median) 58.18% of the time. The kicker seems to come from the flattening curve.

Major US Equities & Factors

When tested on our list of Major US Equities & Factors, Momentum stocks have tended to perform well over the following trading quarter along with Quality, Mid-Cap Growth, and Low Volatility stocks, indicating some risk-off behavior within the equity markets. It’s important to note that the Momentum factor is agnostic of the type and style of stocks that are included in the rebalancing, and primarily looks at stocks with higher-than-average movements over specific look-back periods.

While some investors might be confused to note that the S&P 500 High Quality ETF (SPHQ) was the bottom performer while the MSCI Quality Factor ETF (QUAL) was the #2 performer, it’s important to note that there tends to be little overlap in the holdings. As of 1/27/2022, there is only a 33% overlap*.

For a deeper dive into ETF holdings, please see our recent post on Know What You Own.

*Data via ETF Research Center

Fixed Income

When tested on our Fixed Income list, the data appears to corroborate the bond market’s suggestion of lower growth. Higher duration assets such as Zero-Coupon Bonds and Long-Term Treasuries have historically been the best performers, while higher risk areas such as Emerging Market and High Yield have been the bottom performers. It’s interesting to note that while the higher duration assets have been the top performers, the win rates of these positions have historically been much lower than the loss rates of the higher risk areas of the bond market, meaning that there was a higher probability of high-risk areas losing than there were with lower risk areas winning, which sends a clear risk-off message in and of itself.

Disclosure: This information is prepared for general information only and should not be considered as individual investment advice nor as a solicitation to buy or offer to sell any securities. This material does not constitute any representation as to the suitability or appropriateness of any investment advisory program or security. Please visit our FULL DISCLOSURE page.