Andrea Cicione

We said: Yields set to rise. While a vaccine would likely have a limited impact on GDP in Q4 2020 and H1 2021, our growth and inflation forecasts for H2 2021 and beyond will have to be adjusted higher. This means that sometime next year (perhaps in Q2), the Fed may pull back on its bond-buying programme in response to a smaller deficit, a stronger recovery and less need to intermediate markets. It would be the first step towards raising fed funds rates, but a hike is unlikely to happen before H2 2022. In the meantime, the Fed will push back on any market expectations of higher rates; but yields will probably rise anyway.
Outcome: 10-year US Treasury yield +60bp

We said: Rising yields to spur Growth-Value rotation, again. As regards the Growth-to-Value rotation, the latest attempt was predicated on expectations of a “blue wave” in the US election, which failed to materialize. But a vaccine may succeed where hopes of a large fiscal stimulus did not, namely, by delivering a sustained and faster-than-previously-thought recovery in growth, employment and inflation. All this points to higher yields, which would be good for Financials – still the largest US sector by net income terms, if not market cap. And with consumer and business behaviour likely to normalize, all sectors that have been hit hard by the pandemic (hotels, restaurants, airlines, physical retail etc.) should also begin to recover.
Outcome: S&P 500 (large caps) Value +15%, Growth +6% ; Russell 2000 (small caps) Value + 39%, Growth +24%

We said: We have written how weakness in US new goods orders reflects sagging world trade. EU data releases have further darkened the global outlook, with confirmation that Germany’s economy, the EU’s largest, shrank in Q2. We have also highlighted the extent to which the rest of the world is slowing more abruptly than the US.
We add a trade to the theme of US growth outstripping the RoW. We go long US Transportation and short US Aerospace & Defence. With momentum in the global economy lagging that in the US, we believe Aerospace & Defence will be a relative loser as it is very dependent on non-US earnings. China is a particularly important market. Earnings growth has been strong in the past few years, but we doubt this can be sustained in the current global trade climate. Valuations are also expensive at 21.6x forward earnings.
Conversely, US Transportation is leveraged to the US domestic economy. The sector encompasses freight as well as last-mile delivery. Ahead of the potential increase in tariffs on Chinese imports later this year, not to mention the year-end holidays, we expect significant stockpiling in coming months, which will be positive for freight. At the same time, relatively buoyant consumer spending remains a tailwind for last-mile delivery companies.
We therefore buy the IYT ETF (iShares Transportation Average) and sell the ITA ETF (iShares U.S. Aerospace & Defence). Transportation’s p/e is 13.3x forward earnings (2.7 points below the 10-year average). The differential with Aerospace’s 21.6x valuation provides a good margin of safety for the trade.
Outcome: We closed the trade on 23 October for a profit of 6.58%.