One day after Nomura’s Charlie McElligott pointed out that the long-awaited credit contagion had finally emerged, courtesy of the blow out in GE bonds which has spread to both the IG and junk bond sectors, the market has resumed its turmoil, only this time the risk catalyst is the ongoing chaos over Brexit, and the potential ouster of Theresa May following a flurry of cabinet resignations.
Which is not to say that credit has been fixed: as McElligott writes in his latest note, the price-action in Credit markets right now is a very real “negative” development for risk-assets, and as highlighted yesterday “credit spreads” have previously been a TAME macro factor input for global risk-assets despite the tumultuous returns YTD. This can be seen in the blow out in junk bond spread, which have soared from a 10 year low to the widest since April 2017.
And, as the Nomura cross-asset strategist writes today, “cycle realities” are exposing cracks in Credit, “as the fact that US corporates chose to LEVER into the late-cycle for M&A and stock buybacks instead of DE-leveraging is now driving serious concerns (ratings downgrades, IG trading at HY spreads) and price-behavior asymmetry (stuff trading like the “trapped longs”)—we see this contributing additional downside pressure to risk-assets.“
Which then brings us to the ongoing chaos equities, where yesterday we say more of the same performance “slow-bleed” and “death by a thousand cuts” with shorts again generally outperforming longs with Long-Short in a continued de-risk/gross-down mode according to Charlie, “with late-cycle leaders (and shorts / underweights) “Value” and “Quality” again painfully squeezing against legacy length in “Growth” and “Momentum“
In short, hedge funds are scrambling for direction, praying for momentum, and can’t find either.
Worse, as we discussed yesterday, instead of participating in tactical “chase” behavior into YE, Nomura finds that the Macro community is now more actively shorting U.S. here on the increasing vulnerabilities, and instead of just looking for a convenient spot to “BTD”, sentiment has flipped with shorts now actively being pressed.
There is one important consequence of this reversal: unlike previously when funds were looking to ride the buying wave higher, many now appear to have given up, and as this market “chop” pushes into the late-month G20 volatility event of the Trump-Xi meeting, funds’ resolve to actually take risk back-UP is effectively “nowhere” with many funds acting “frozen” according to mcElligott.
And since no McElligott update would be complete without a look at the Greeks, here is what the latest Nomura numbers show:
- S&P options are showing VERY defensive posture change since last week, -$520.5B delta (1st %ile since 2013) and -$18B of gamma per 1% move + or – (also a 1st %ile outcome since 2013)
What are the implications: as McElligott concludes, “this means potential for EVEN MORE INSANE price-action and VIOLENT up / down “chop,” with extreme short-gamma on both sides at a time where we sit near pivot-points for systematic de-leveraging and re-leveraging.”
Then again, as Goldman demonstrated yesterday when it attributed the violent moves in crude to “negative gamma”, this has become a catch phrase to explain pretty much anything in the market that no longer complies with conventional expectations. Whatever the reason, however, in light of the virtually nil liquidity in the market, we certainly agree with McElligott: expect increasingly “more insane” price action as more funds are forced to realize that no central bank is coming to their rescue this time around.
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