The return of correlations

Equity Market Outlook and Risks (Jill Carey-Hall)

• S&P 500 12-Month Target: Set at $7,800, implying modest upside from current levels; risks are deemed balanced.
• Earnings Forecast: 2026 and 2027 earnings forecasts were raised; current year growth projected at 33%, slowing to 12% next year.
• Cautious Drivers:
  • Liquidity & Policy: Worsening liquidity environment driven by fewer rate cuts and potential hikes globally, including U.S. forecasts.
  • Supply/Demand: Negative equity supply/demand dynamic due to increased issuance outpacing slowing buybacks.
  • Macro Factors: Persistent geopolitical tensions and sticky inflation, which historically correlate inversely with market multiples.
  • Earnings Quality: Divergence between free cash flow and reported earnings amid high capital expenditure (CapEx).
• Sector Allocation: Maintained market weight in Tech and Communication Services; favor stocks with positive gearing to nominal growth and inflation-protected income.
• Bull Case: Continued productivity boom driven by AI and efficiency gains, historically favoring labor-light stocks.

Interest Rate Impacts and Asset Allocation (Jill Carey-Hall & Bruno Brazegna)

• Critical Rate Levels:
  • 6% to 7% (10-Year): Historically significant thresholds where S&P 500 returns become negatively correlated with rising rates (6%) and P/E compression occurs (7%).
  • 5.5%: Historical inflection point where asset allocation begins shifting from equities to bonds due to widening yield spreads.
• Corporate Balance Sheets: Remains resilient with net debt-to-EBITDA below average; 80% of S&P 500 debt is long-term fixed (vs. 60% in 2007).
• Volatility vs. Levels:
  • Focus on MOVE Index: High volatility in the MOVE index (specifically top quartile weekly changes) creates deeper negative returns for risky assets than high rate levels alone.
  • Uncertainty Repricing: Recent volatility increases are driven 75–80% by pricing of uncertainty (policy, inflation, duration risk) rather than mechanical basis point moves.
• Treasury Diversification:
  • State-Dependent Hedge: Treasuries only provide negative correlation (hedging benefits) during acute risk episodes, not during initial phases of macro weakness.
  • Volatility Threshold: Negative correlation recovers when term-structure volatility inverts, indicating front-loading of near-term risk.
  • Strategy Recommendation: Maintain duration exposure but explicitly add convexity (option overlays) to capture non-linear hedging utilities.

Technical Strategy and Positioning (Chintan Kotecha & Paul Sianna)

• CTA Positioning Risks:
  • Crowded Trade: CTAs are historically max-short on the U.S. Treasury curve (short notional 114% of assets), exceeding 2022 levels due to lower current volatility.
  • Industry Exposure: Industry-wide short position estimated at ~$280 billion (10-year equivalents) across ~$300 billion in CTA assets.
  • Unwind Mechanics: Covering begins in the long end (ultra-long bonds) and will propagate to the front and belly with roughly 5–15 basis points of further rally.
  • Pain Trade: A "growth scare" scenario (yields fall, equities drop, dollar weakens, oil drops) forces systemic unwinds across all asset classes; a 1.5% NASDAQ drop could trigger ~$86 billion in global equity sales.
• Yield Trend Outlook:
  • Continued Upside: No technical evidence (trend exhaustion, oscillator divergences) suggests the yield rally has peaked; breakout above October 2023 high on Sept 23, 2026, signals the start of a new phase.
  • Wave Analysis: Completed an impulsive "Wave 3 of 3" move; a corrective "Wave 4" followed by a final "Wave 5" higher is expected.
  • Technical Targets: Textbook target for 10-year yield is 5.75%; rational outcome includes 6% to 6.25%.
  • Re-entry Level for Shorts: Considered in the 4.92%–5.02% range, representing a retest of the Oct 2023 peak and the late Sept breakout low.
  • Curve Structure: The 2-year yield is the only segment below its prior peak; expected to follow the 30-year, 10-year, and 5-year to new cycle highs.
• Oil Correlation: Continued bullishness on oil (targeting $129/barrel) supports the higher yield thesis; a bottom in oil was called in 2026 with upside remaining.