Traders, analysts and strategists have been stumped by a market paradox in recent weeks: despite earnings that have been off the charts, rising 24% Y/Y (the most since 2010, if largely thanks to Trump's tax reform), the S&P is still down for the year, after experiencing two brief 10% corrections just the past four months after a torrid, melt-up start to 2018. 

How come? While many have offered explanations why the market refuses to break out higher, one of the most convincing observations comes from Matt King, who in his latest note points out that it is all about rates, both nominal and real, and how they influence risk assets. That particular interplay is especially notable because as the Citi strategist writes, whereas straight market correlations between both nominal and real yields and risk assets tend to prove unstable, “they can be thought of as following a regular cycle.”

The cycle in question, which is shown below…boils down to one thing: competition for investment flows.

King suggests thinking of the 5 steps as follows:

Note the critical role central banks play in this cycle: they are the de facto catalyst, whose monetary policy intervention serves to mark the trough in the cycle once risk assets hit the so-called “Fed Put”, whose new strike price under Jay Powell was quantified last week by Deutsche Bank at roughly 2,300-2,400 in the S&P 500.

While King admits that the “Real Yield Cycle” is merely a simplification, it does seem to fit relatively well with both credit and equity moves over recent decades, and “would suggest that risk assets will continue to be vulnerable – and that even if yields start falling again, it may well be as part of a flight to quality.”