Month: September 2020

Back on August 18, a little-followed quant at JPMorgan, Peng Cheng, came out with what may have been the most prophetic (and timely) market analysis in recent months, when he – unlike his “strategist” peers at major banks were trivially hiking their S&P year-end price target to keep in lockstep with the market – urged clients to take cover as he voiced concern about the near-term future of technology stocks, thanks to a combination of factors from a worsening market concentration and factor crowding, to the potential for improving Presidential polls for President Trump, rising rates (a 20 bps increase in the month of August) and increasing US-China tensions.

“With the long-end of the curve already threatening a confluence of threshold signals for yields to break higher, continued price weakness has the potential to trigger another flow of momentum based selling pressure,” Cheng wrote on the last Friday of August, adding that “Rising rate risk and factor crowding, the potential for improving presidential polls for President Trump, and increasing U.S.-China tensions provide reasons for investors to consider hedging near-to-intermediate term risk.”

He was dead on, because what followed just a few days later – in no small part as dealers tried to savage SoftBank’s gamma exposure (which had been mostly closed by then) – was the fastest 10% correction in the Nasdaq from an all time high in history.

So with the burst of selling behind us, and some speculating that the rally will now continues, what does Cheng think will happen next?

As he writes in his latest note, “from a volatility perspective, our observations have not changed since our previous report” and clarifies that “despite the recent volatility, the demand for calls continues to dominate the NDX volatility pricing.“

This means that the core dynamic which we discussed extensively for much of August, namely the relentless increase in implied vol as retail daytraders/SoftBank/whoever bought calls on high-beta, tech and momentum names pushing their stocks to record highs continues, and it was this dynamic that cracked on Sept 3, sending tech into a furious tailspin.

In short, the selling isn’t over.

Below we share some more observations from Cheng’s latest note, in which he first observes the NDX skew has flattened further (Figure 1 and Figure 2). At the same time, implied volatility has picked up alongside realized volatility, and the NDX volatility risk premium remains expensive.

Echoing what we said virtually every day for much of August, the JPM quant also writes that “while both SPX and NASDAQ vol experienced spot up, vol up dynamics in the month of August, we believe the increase in  NASDAQ volatility is driven largely by the demand for calls.” When Cheng decomposed the one-month change in Nasdaq implied vol (the VXN Index) into individual NASDAQ option strikes, he found the call wing contributes to the majority of the increase. This contrasts with the VIX index, where the contribution between calls and puts was roughly equal.

Meanwhile, at the single stock level, JPM also observes skew steepening as we did especially in the case of Apple on Aug 25, even recommending a trade that has since resulted in substantial profits…

…  but finds the magnitude is small relative to history, which of course is to be expected considering “history” includes the devastation from March.

In any event, and what remains the the key point about recent option dynamics, the recent trend is skew is accompanied by a significant pickup in call option trading volume.

Putting it all together, Cheng writes that while he continues to view institutional investors as key drivers in this month’s equity correction – as confirmed by recent revalations about SoftBank becoming a “Nasdaq whale” – with tech/momentum stocks decoupling and reaching extreme overbought levels, retail investors likely played a role as well according to JPM, which notes OCC data on small option trades as evidence as it is a proxy for retail investors…

… while the flattening of skew is also consistent with retail investor behavior. That said, the JPM quant issues a warning, citing his previous academic studies in which he found that “stocks popular with retail investors tend to outperform in the short term but revert those returns in the long term.”

* * *

So if the selling is not over, what are the best trades? According to JPM, besides merely shotgunning shorts, a more nuanced trade is QQQ Put ratios: given the current volatility pricing, Cheng continues to favor the put ratio structure for tail protection. In addition to the previously recommended resettable put ratio, the structure in vanilla format also appears attractive. Indicatively, selling 1x 3M ATM put on QQQ against buying 1.9x 3M 90% puts can be entered at zero cost upfront (ref. 277.88). The 90% strike also coincides with a number of medium-term technical supports for the NDX.

A second trade which he pithced recently, but which has run its course for now, is Put vs put dispersion: “Volatility on single stocks have reset meaningfully higher, making the put vs. put dispersion less attractive (Figure 10). Therefore, we suggest waiting for a better entry point to implement the trade.”

Authored by Mike Shedlock via MishTalk,

Estimates vary widely from 4 to 9 years depending on the source.

Why Airline Traffic Won’t Fully Recover Soon

Leeham News discusses Why Airline Traffic Won’t Fully Recover Until the Mid-Late 2020’s.

Many journalists and industry observers have been obsessively searching for “green shoots” indicating the beginning of a recovery, but much of this commentary misses the mark. 

Last month, investment research firm Bernstein published an analysis calling for narrowbody traffic to recover by 2023 and widebody traffic by 2025. 

Lehman Offers This Assessment

• Bureaucratic caution will lead most countries to take an additional 6-12 months after herd immunity is achieved before reopening to most inbound non-resident passengers.

• Even for domestic or regional travel, passengers must feel safe from infection before they’ll fly again. 

• Countries with greater internal consumption of domestic production should recover sooner than trade-dependent countries. Accordingly, domestic travel in the US, EU, and China is likely to return sooner than in most other regions.

• Getting business travelers back on airplanes will require renewed economic activity, in addition to the obvious safety requirements.

• Improved video conferencing technologies like Zoom, Skype, and Google Meet make a similar structural shift all but inevitable as businesses learn how to operate in a COVID-impaired world where air travel is challenging and inconvenient.

• As long as travel demand remains depressed, supply will fall in other parts of the travel ecosystem, especially hotels.

• Airlines that restore capacity too quickly will see their profitability dented as too many seats chase too few passengers.Bottom line: Global air travel won’t be back to pre-COVID volume for several years

I selected the above bullet points from a long article. Here is Leeham’s Bottom line:

“Global air travel won’t be back to pre-COVID volume for several years”

That assessment was from July and it did not change on September 7 in an article that discussed Twin-Aisle Leasing Market Challenges.

The timeline for a passenger traffic recovery remains uncertain. The IATA does not expect passenger traffic to return to pre-COVID-19 levels until 2024. Leeham Co. predicts that it will take four to eight years before traffic returns to pre-COVID-19 levels.

Long-haul markets, where airlines almost exclusively operate twin-aisle aircraft, witnessed the sharpest drop in passenger traffic. As outlined in a previous article, airlines already retired significant numbers of older aircraft. Due to lingering travel restrictions, those markets should be the slowest to recover to pre-pandemic levels.

There are virtually no takers for second-hand widebody passenger aircraft now. Separately, Airbus and Boeing decreased their passenger twin-aisle production rates from a combined 28 to 15 per month from next year: 787 at six, A350 at five, 777 and A330 at two each.

Simply put, Nomura’s MD of Cross-Asset Strategy, Charlie McElligott, warns, it’s not over yet…

Yesterday was a reminder on the magnitude of the $Gamma clean-up that is being worked out of by the US Eq Vol Dealer community as per the 50-handle S&P mush-down in the final hour of the session…

The Tech mega-cap single-names notably fell all while Vols (VIX and VXN both ‘down’) and Skew underperformed significantly despite the index-level market move sharply lower… “spot down, vol down”

…simply because base Vol remains really elevated / rich and has more room to reprice lower…

Currently we see S&P holding kinda-sorta approx around the “Gamma Neutral” line of 3353 (ex 9/11/20 expiry), while we’d expect Delta to “flip” below 3280.

It of course is also likely we are finally getting some Asset Manager selling-down of that prior 100%ile (since 2006) net $long position in S&P futures, as we saw “large lots” futures selling really pick-up midday and continue all the way into the close yesterday

As recently discussed here too, back on the subject of Vol Control funds – where I’ve highlight recently the speed & violence of the realized vol correction, and its impact in now making 1m realized vol (21.6, 66th %ile) higher than 3m (18.0, 49th %ile) for the first time since July.

This matters because it means that since yesterday, our VC model has switched to that “1m realized vol lookback window” (and not 3m) to determine the target Equities allocation; and this comes simultaneously as the 3m was set to substantially add more equities exposure, due to that large -5.9% day back on 6/11/20 having dropping out of said 3m realized vol lookback sample.

There is still buying to do in a scenario of a swift resumption to “0% daily mkt move” days, which would need to be sustained in coming weeks…

…however, there is now a far greater probability now than before that more daily swings which keep 1m realized ‘averaging up’ will drive instead incremental “sell” flows from VC, which has now SOLD -$14.2B of US Eq over the past 1w due to this “vol tremor,” after previously having having added ~$70B over the past 3m.

Just as we warned on September 3rd, as we first exposed Softbank’s shenanigans…

Next: fast vol-targeting funds start selling, then risk-parity, etc.

— zerohedge (@zerohedge) September 3, 2020

And that is just what has happened since that incessant, irrational, over-leveraged bid has left the market…

As McElligott notes, there’s a lot more “selling” to come if those Vol-Control funds reverse.

We have documented over the last month the billions of dollars in compensation Tesla CEO Elon Musk has received as a result of – not production goals – but compensation awards tied to metrics like market cap, EBITDA, and basically the company’s stock price going up. 

Days ago we noted Musk had earned $9 billion in compensation in just 3 years, despite the ongoing mystery of Tesla’s historic stock rise and the company running a $6 billion accumulated deficit at the same time. 

Much of the company’s recent stock rise has been attributed to chatter about the company being placed in the S&P 500 index. When Tesla was snubbed for inclusion in the index last Friday, the stock fell more than 20% from its highs. And now, as Charley Grant of the Wall Street Journal points out, it may be Musk’s compensation that disqualifies Tesla from future inclusion. 

New expenses associated with GAAP accounting for Musk’s compensation could threaten the four consecutive quarters of profitability that the company needs to qualify for inclusion into the S&P 500. Those rules state that there must be a GAAP profit in the most recent quarter and cumulative profitability over the previous four quarters, Grant writes.

Tesla had acknowledged some of Musk’s bonuses in the past, but they had been so small in nature that they allowed the company to still post a small GAAP profit. Now, with the company’s market capitalization having risen almost 10x off its 2 year lows, it could wind up costing Tesla shareholders more. 

Grant writes:  

“A third-quarter net loss of just $226 million would put Tesla in the red over the past four quarters. Given the size of the options awards and the recent gains in Tesla’s share price, a billion-dollar quarterly compensation expense is within the realm of possibility.”

We noted last week that in a matter of less than 36 months after Musk’s pay plan was put into place – a pay plan that had a 10 year runway – the CEO has amazingly hit milestones that have qualified him for billions of dollars in stock options. 

With the stock’s recent performance, Musk qualifies for another 8.44 million in stock options, which he will add to the 16.9 million in options he unlocked in may and July, we noted.

His latest tranche was unlocked after Tesla’s 6-month and 30-day average trailing market value both exceeded $200 billion. Another performance goal — logging a combined $3 billion of adjusted earnings before interest, taxes, depreciation and amortization topping $3 billion over four quarters — was achieved as of June 30, a filing shows.

Many who were critical of Musk’s compensation plan said it offered little incentive for the company to reach profitability, only to grow in size of market cap. Back in 2018, even the New York Times called Musk hitting his pay plan goals “laughably impossible”. 

But instead, Musk did it. And he did it in less than three years. And for a stunning comparison, while Musk was taking in $9 billion in compensation, Tesla was adding to a $6 billion accumulated earnings deficit. 

By Michael Every of Rabobank

So how did the European understudy do yesterday? To be fair, it was not a star turn.

ECB President Lagarde did not do as badly this time as in her infamous early press conference where she suggested the bank was not interested in what happened to peripheral Eurozone government yield spreads(!), but still managed to take what was ostensibly a shift in the ECB’s concerns towards the strength of EUR and make it seem as if the bank didn’t care about that either – and so we initially saw a stronger currency. You could almost hear the face-palms and clenched teeth of various ECB officials while she was speaking.

Fortunately, that spike in EUR did not last very long, because what is going on with Brexit took the headlines, as the understudy was shoved offstage into the orchestra pit by one of the chorus line – BoJo in a tutu leaping forward to scream at the world “Look at me!”

As things stand now, the UK government is going to press ahead with the next reading of its controversial new Internal Market Bill on Monday. That is despite the EU saying that it will start legal proceedings if it does, as well as instigate a trade war, with an end-September deadline to drop the bill. This raises the risk of not just a Hard Brexit, but the hardest of all possible Brexits, one where the well is poisoned and the earth salted. (And the fish go uneaten and cheese unsold.)

It should also be noted that the reaction from the US Congressional side, in the form of Nancy Pelosi at least, has been that if this happens, the UK can forget about a US-UK free trade deal. China is also not exactly itching to help the UK out right now too after the whole Hong Kong thing. (On which note, breaking international law and agreements is hardly the ideal platform for the UK from which to critique others for doing the same.) The new, global, free-trading Britannia is about to sink below the waves on launch, it seems – unless Tony Abbot can smuggle in a lot more than budgies, and pronto.

Even within the Tory party itself, a rebellion appears to be brewing between those backing the government line and those who think that things like the international rule of law matter.

At this stage one would assume that the most logical resolution would be for the UK to back down: however, there appears absolutely no sign at all that this is going to happen. It would be a very hard sell, even for a government that enjoys Covid-19 U-turns on a daily basis. Indeed, this is their bread and butter and fish and chips issue – “Getting Brexit Done.”

As such, mark GBP as one of the currencies successfully flagged here recently as susceptible to the kind of geopolitics markets keep saying isn’t going to happen, “because markets”…until it does. Indeed, at time of writing GBP was 1.2827 vs. 1.3031 as yesterday’s intra-day high. Where does one price sterling if the UK heads for an acrimonious Brexit as an international law breaker and with no trade deal with any of the Big 3? BoJo’s tutu doesn’t cover as much as it should, sadly.

Meanwhile, speaking to market events that “nobody sees coming”, the US has confirmed there will be no extension of the deadline to close or divest TikTok. Four days to go, and two of them are a weekend. The problem is that new Chinese rules likely mean a sale cannot proceed, so it may have to just close. That must surely be a further warning shot that in our current global environment, value can rapidly move from a presumed X to 0 if the politics changes.

Similarly, Turkey yesterday floated that its Black Sea gas field could be up to 1tcf. However, besides what is recoverable and how long it takes to extract it (years), the backdrop is seven EU leaders have told Turkey it must agree to talks or face sanctions over its energy exploration in the eastern Med. These are ready for discussion as soon as the September 24-25 EU summit. Indeed, yesterday French President Macron went on a Tweeter storm: “Pax Mediterranea!” and “For stability and security, for biodiversity and the climate, there is a collective interest in the Mediterranean in asserting our European sovereignty.” Greek press underline they expect France to offer Greece full military support, if necessary.

Meanwhile, off the market radar, Turkish foreign ministry has stated it “completely rejects” the recent Arab League resolution condemning its actions vis-à-vis Libya, and has deplored Macron’s “incompetence.” Reports also suggest Turkey may be dragged into the Armenian-Azerbaijani dispute over the Nagorno Karabakh enclave. What’s one more potential military front? A lot more money is what. And on said money, TRY is another currency seeing geopolitics and economics weighing on it, standing at 7.44 at time of writing. Bloomberg reports new efforts are being made to coax gold into the economy: when someone is going for gold, you knows things are serious.

This is surely the last thing the American people want to hear, but it does confirm President Trump’s recent statements saying that top Pentagon brass essentially seeks out constant wars to keep defense contractors “happy”: the Department of Defense plans to cut major military contractors a $10 billion to $20 billion COVID bailout check.

Defense One reports: “With lawmakers and the White House unable to come to an agreement on a new coronavirus stimulus package, it’s unlikely that money requested to reimburse defense contractors for pandemic-related expenses will reach these companies until at least the second quarter of 2021, according to the Pentagon’s top weapons buyer.”

Defense undersecretary for acquisition and sustainment, Ellen Lord, in recent statements has indicated the private defense firm stimulus would cover the period from March 15 to Sept. 15 and is estimated at “between $10 and $20 billion.”

“Then we want to look at all of the proposals at once,” Lord said at a press briefing Wednesday. “It isn’t going to be a first in, first out, and we have to rationalize using the rules we’ve put in place what would be reimbursable and what’s not.”

And strongly suggesting that it won’t be the last of such stimulus for defense firms who have already profited immensely off post 9/11 ‘wars of choice’ launched under Bush and Obama, Lord said, “I would contend that most of the effects of COVID haven’t yet been seen.”

To recall, here’s what Trump said at the start of this week:

“I’m not saying the military’s in love with me,” Trump added, as he advocated for the removal of U.S. troops from “endless wars” and lambasted NATO allies that he says rip off the U.S. “The soldiers are.”

“The top people in the Pentagon probably aren’t because they want to do nothing but fight wars so all of those wonderful companies that make the bombs and make the planes and make everything else stay happy,” he added.

“Some people don’t like to come home, some people like to continue to spend money,” the president said. “One cold-hearted globalist betrayal after another, that’s what it was.”

The “outrage” that followed included reporters claiming that Trump’s words were “unprecedented”.

But that’s far from the truth, as Glen Greenwald reminded his fellow journalists:

After fighting a brutal war & then serving eight years as US President, here was Dwight Eisenhower’s 1961 warning about the menacing joint power of the US military and the private arms industry. This was before Vietnam, the Reagan Cold War build-up and post-9/11 militarism: pic.twitter.com/IRl8ZTdpIo

— Glenn Greenwald (@ggreenwald) September 7, 2020

Well over a half-century ago, Eisenhower warned, “In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”

And further: “We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together.”