Value Is Catching Up (Really!), Fed Funds Still Flat

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Value Is Catching Up (Really!), Fed Funds Still Flat

Two Data items today:

#1: With all the recent excitement about higher long-term Treasury rates, we got to wondering if any of this optimism over economic growth has filtered through to Fed Funds Futures (FFF) contracts. These have been, for many years now, much better indicators of shifts in Fed policy than either Wall Street economists or even the Federal Open Market Committee itself.

The short answer to the question “are Fed Funds beginning to think that the US economy will be strong enough to see a rate hike before mid-2022?” is a resounding, 100% “NO”. The data from the latest FFF contracts:

  • As of Friday, May 2022 is the last contract month with market-based prices (i.e. with actual trading volume).
  • The price of that May 2022 contract is 99.955, which implies Fed Funds will be 4.5 basis points (0.0045 pct) at that point. Friday’s actual Fed Funds rate was 9 basis points.
  • Contracts between October 2020 and April 2022 imply Fed Funds will be between 8-9 basis points (through the end of 2020) and 4 – 8 basis points from January 2021 to April 2022.

Now, let’s look at 2-year Treasuries, the most sensitive part of the yield curve to changes in Fed policy, to see what this market says. Here are 2-year yields back to May 1, 2020, with a highlight box for June 8th. That was essentially “peak confidence” that the US economy was recovering quickly.

As you can see, 2-year Treasuries have not really budged in for the better part of 3 months and at a 0.16 percent effective yield don’t impute anything more than 2 years of Fed Funds similar to today’s 0 – 25 basis point range.

Takeaway: as much as the long end of the Treasury yield curve is starting to signal more market optimism about a US economic recovery, we’re nowhere near escape velocity for the short end of the curve.

#2: It’s been a while since we took a deep dive into the Growth vs. Value debate, so today we’ll look at how each equity investment style has fared this month-to-date and for the year-to-date as well.

Among large caps, Value is doing better this month (beating Growth by 1.2 percentage points) but it is nowhere near catching up with Growth on a YTD basis:

  • S&P 500: +7.3 percent YTD, +3.0 pct October MTD
  • S&P 500 Growth: +22.7 percent YTD, +2.8 pct October MTD
  • S&P 500 Value: -10.1 percent YTD, +4.0 October MTD
  • YTD, Growth is still +32.8 percentage points versus Value

In Small Caps, the YTD gap between Growth and Value is not quite as pronounced (22.8 points) and Value is catching up at a faster clip (4.2 percentage points MTD):

  • Russell 2000: -1.7 percent YTD, +8.8 pct October MTD
  • Russell 2000 Growth: +10.6 percent YTD, +7.0 October MTD
  • Russell 2000 Value: -14.2 percent YTD, +11.2 October MTD

The bottom line is that October has been a catch-up month for Value, but why? It comes down more to stock and sector performance than “style”:

Large Cap differences:

  • A third of the S&P Large Cap Growth index is in Apple, Microsoft, Amazon, NVIDIA, Visa and Mastercard. None of these archetypal Growth stocks has beaten the S&P 500 this month, with MTD returns ranging from +2.8 percent (MSFT) to -2.5 pct (MA).
  • Conversely, Financials are 18.4 percent of the Large Cap Value Index (versus 4.3 percent of Growth) and that group is finally getting a little oxygen, up 4.9 percent October MTD. Industrials, a group we still very much like, are also a Value overweight (10.6 pct vs. 7.0 pct) and up 5.4 percent this month-to-date.

Small Cap differences:

  • Small Cap Financials are on a tear in October, up 9.7 percent. The group is 27.5 percent of Small Cap Value but just 4.3 pct of Growth.
  • Small Cap Industrials are also doing well this month, up 7.8 percent. This sector is 16.7 percent of Value, more than the 13.7 pct allocation in Growth.
  • Small Cap Health Care is “only” up 6.2 percent MTD. Value has a 6.6 pct weighting, where Growth has a 34.2 pct weight. This sector’s performance does go a long way to explaining why October has been kinder to Small Caps than Large. Not only is Small Cap Health Care up 6.2 pct October MTD versus Large Cap Health Care +2.2 pct MTD, but the sector is a heavier Russell weight (20.9 pct) than S&P 500 (14.1 pct).

Takeaway: as always, we recommend you discard “growth” and “value” labels when considering investment approaches and look at sector performance and fundamentals. Some parts of Value look good to us (Industrials) and others like Financials do not.