Small caps shoot for the moon

Outperformance starting to raise eyebrows

Chart of the Day

The key driver of markets yesterday was the news that the Democrats had taken control of the Senate after winning both Georgia run-offs. The increased chance that the incoming Biden administration will be able to follow an agenda of increased fiscal spending ripped through markets, with one notable development the 4% jump in the small-cap Russell 2000 equity index. The index is now running far ahead of the S&P 500 since the start of last year.

Macro

Markets continue to look through the recent weakening of the data. The big macro news was that the ADP December payroll data showed a fall of 125,000, which implies Friday’s non-farm payrolls report might also come in weaker than economists expect.

Australia’s exports have been lifted by stronger demand from China in recent months, but it is imports that are surging now that the coronavirus has been brought under control - that is likely to be a similar trend elsewhere once vaccination programs get underway.

Markets

It was essentially a further leg of the rotation trade today, with traders moving out of those tech stocks that did well during the pandemic and into more cyclical sectors.

Despite the events on Capitol Hill, the VIX closed slightly lower today. And despite the increased chance of even greater fiscal spending, the MOVE index of implied bond market volatility dropped sharply.

That was despite bond yields jumping across the curve.

And the spread between the 30-year and the 5-year jumping to the highest in years - the spread also rose sharply in Canada, but barely moved in Europe.

One important point is that, unlike in the past few weeks, it is not just inflation expectations rising. The 10-year breakeven and 10-year real rate were equal drivers of the rise in the nominal yield. That will have important implications for assets such as high-growth tech stocks and gold if it continues.

Gold traders already showed their nerves, selling the metal down by over 2% despite the relatively modest move in real rates.

Some might argue the zero-yielding cryptocurrencies should react similarly to gold when real rates rise, but in fact they continued their ascent higher.

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