March Madness – The rise of volatility, yield and meme stocks

Concerns of inflation and rising U.S. yields have been wreaking havoc in recent weeks, with volatility rising and broad sell offs observed in the Nasdaq.

The rally in U.S.0-year yields, watched closely by market participants have rallied into the New Year as inflation expectations have picked up. Increasing commodity prices in grains, metals and materials has also put pressure on rates. Similarly, the dollar has continued to decline, with the U.S. government announcing further stimulus and monetary policy on infrastructure and healthcare.

This has led to a profound effect on markets, as shown below:

Fig 1: U.S.10Yr Yields, vs sector ETFs Energy (XLE – Orange), Financials (XLF – Yellow) and technology (XLF-purple).

We see that as U.S. 10yr rates rise, inflation sensitive sectors such as financials and energy have seen rallies. Energy demand has been exacerbated, due to perceived demand for Summer 2021, as the global economy continues to reopen due to rapid vaccine rollout, while OPEC opted to keep a lid on supplies from their meeting in early March. Recent adverse weather in Texas also increased short term demand in the U.S. Furthermore, with increasing yields, pressure has eased on financials allowing a rebound in prices due to widening spread, although less favourably than energy.

Consequentially, many overbought tech and momentum stocks have collapsed as yields reverse. As yields rise, investors move out of higher risk cash producing stocks and into debt instruments with lower risk. As such, popular tech names have sharply sold off and the technology sector ETF (XLF), as shown in Figure 1, has declined sharply. Popular tech stocks and ‘meme’ stocks such as TSLA, WKHS, PLUG and the ARK innovation ETF, among others have seen deep corrections.

Movement in yields have further been rocked by weak demand for treasuries and the speculative commitment of trader’s short positions in treasury markets, observed in the TLT ETF. This further reinforces the inflation driven narrative which still remains sensitive to U.S. Federal Reserve commentary.

The return of value?

Fig 2: VTV/VUG – Vanguard Value ETF/Vanguard Growth ETF

Since the uptick in yields, from the start of the new year, the Vanguard value ETF (VTV) plotted vs the Vanguard Growth ETF (VUG) has seen upside. Tech stocks have seen multiple compressions and cheap sectors of the markets are becoming more favourable to investors due to the time value of money (cost of future growth).

Furthermore, inflows into the Russell 2000 small cap index have seen strength since the turn of the new year. Note the ~30% spread of the Russell 2000 (tracked by the IWM Russell 2000 ETF) above the S&P500, as shown below in Figure 3.

Figure 3 : SP500 vs Russel 2000 ETF (IWM).

Closing Remarks

The volatile market continues to offer opportunity. Steepening U.S. yield curves present risk off scenarios for stocks and increased bouts of volatility. However, long opportunities remain, given lofty valuations and tech markets breaking to all-time highs, opportunities remain to hedge long positions to take advantage of multiple compression and volatility surges. Energy, and inflation sensitive sectors provide tailwinds for further long opportunities going forward, mean while, technology continues to see volatility and at most risk of a broader sell off.