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The US cash market open sparked a panic rotation into big-tech (growth) and out of value (Small Caps). One of the worst performers of the cash session has been airlines due to Europe gloom despite a boost in US travel over the weekend. 

International Consolidated Airlines Group, with segments that include British Airways and Iberia, two value carrier, Aer Lingus and Iberia Express, and two low-cost carriers, LEVEL, and Vueling, closed down more than 5% on London exchanges Monday as the UK government warned that COVID-19 cases could restrict travel this summer.

Even with the average number of new daily cases in the UK has declined substantially in recent weeks, top UK leaders tell people not to travel this summer due to the risk of new COVID-19 variants and additional travel restrictions. 

But for Europe as a whole, new virus cases are surging compared with the US that is dropping.  

The rollout of vaccines in Europe has also been slower than the US. The latest concern over a possible connection between the Oxford-AstraZeneca vaccine and reported blood clot appears to have already slowed down vaccinations. There are threats the continent is facing the third wave. 

Helen Whately, Minister of State for Social Care, told BBC this morning that “it just feels premature to be booking international holidays at the moment.” She repeated comments made by Defence Secretary Ben Wallace on Sunday.

This comes as “Paris lockdown, Italy’s national restrictions and rising concern in Germany over infection rates are being reflected in growing fears that the second summer of travel will be lost,” Goodbody analyst Mark Wallace told the FT. 

Investors also panic dumped airlines in the US. JetBlue and Spirit Airlines were some of the worst performers around 1300 ET. 

S&P Airlines index slump more than 2%. 

Airlines in the US are down despite a surge of US travelers. The Transportation Security Administration screened more than 4.3 million people between Friday and Sunday, setting a new high since the virus pandemic devastated travel a year ago.

“TSA screened 1,543,115 people yesterday, Sunday, March 21. The last time checkpoint throughput topped 1.5 million was March 15, 2020–just more than a year ago. Yesterday was also the 11th consecutive day with checkpoint volume exceeding 1 million,” tweeted TSA spokesperson Lisa Farbstein. 

It’s surprising that investors algos are focused on European developments rather than the US. 

Last August, just before we learned that SoftBank was forcing a marketwide gamma squeeze in tech names, a little-followed quant at JPMorgan, Peng Cheng, came out with what may have been the most prophetic at the time market analysis, 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. 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.

Fast forward to today when Peng looks at arguably the most remarkable phenomenon in today’s market, namely the unprecedented – “breathtaking” as Goldman puts it – explosion in retail trading activity…

… with daytraders buying not only single-name stocks but aggressively loading up on levered bullish bets in the form of calls, resulting in “elevated” call volume with Goldman noting that “S&P 500 single stock put-call skew is at its lowest level in years” and adding that “single Stock skew weighted by the notional value of options traded in the US market suggest the demand for calls is even higher.”

However, thanks to Peng’s work, it now appears that the narrative of retail buying which for the past year had been seen as one of blind purchases of risk assets coupled with layered call buying for outside returns (which in turns led to an aggressive gamma feedback loop) driven by the WallStreetBets reddit message boards…

… will need to be reworked substantially because retail investors are rapidly learning and adapting to how to trade the market.

First, here is a breakdown of a recent extensive analysis of retail trading which the JPM quant put together…

We are able to identify retail market orders in the US equity options market as seen in Figure 1, expressed as a % of total options maket volume. Our estimates on options are also compared against those on US cash equities. Retail activity appears to be substantially higher in the options market than in the cash equity market.

… and in which he found that retail does not appear to be overly active in small-cap stocks; in fact, the opposite appears to be true (Figure 2). In terms of sector preferences, most of the sectors are similar in retail exposure, with the exception of Utilities and Real Estate. In those two sectors, the retail participation is much lower than average.

In addition to single name stocks, ETF options are also popular with retail investors. Equity ETFs, including SPY, VXX, and QQQ, have the highest retail participation (Figure 4). This contrasts with index options, which include SPX, VIX, and NDX. To illustrate, JPM finds retail orders make up about 0.2% of the SPX volume but 16% of the SPY volume. Fixed income and currency assets are the least popular ETFs among retail investors. Retail investors also have a preference for leverage on leverage: JPM finds that options on leveraged ETFs are much more likely to be traded by retail investors than non-leveraged ETFs (Figure 5).

None of this is news. It is also not news that retail investors broadly prefer trading calls to puts (see the Goldman chart above). In JPM’s sample, activity in calls outweighs activity in puts by approximately 1.9:1, while on all trades other than retail market orders, the call/put ratio stands at 1.5:1. Retail investors also prefer to trade short-dated options, as Figure 6 shows that over 55% of all retail market orders are on maturities less than one week. At very short maturities, near the money options are the most  actively traded. However, as maturity increases, the preference gradually shifts to more out of the money strikes.

The report also finds that although shorter-dated options activity dominates the options market in general, the concentration of retail traders is still evident after controlling for overall market activity. Figure 7 shows the retail market orders as a % of total market volume. The pattern remains the same: retail investors are major liquidity takers at the very short tenor.

Again, none of this is strictly unexpected or news, and complies with widely accepted narrative on daytrader activity. Where a surprise did emerge, is when JPM looked into the directionality of retail the trades. Here, JPM finds that overall, “retail investors are net buyers of calls and sellers of puts (Figure 8). The net supply/demand imbalance only amounts to approximately 2-3% of the total retail market orders (Figure 9).”

And while there is little surprise in the list of most bullish option flows (Table 1) as all of the names are also favorites based on our analysis of retail flow in cash equities, and it is clear that investors are using options to express positive directional views…

… where there was a notable surprise, was in the list of the names with the most bearish options flow (Table 2).

What this shows is that retail investors are heavy buyers of VIX puts, likely with the intention of earning the roll down of the VIX term structure. Also quite remarkably, the number of call-buying trades on QQQ is quite significant but is outweighed by put-buying  trades. This is in stark contrast to the order flow in the underlying equity market, where retail traders have been net buyers of QQQ and related ETFs. This suggests to JPMorgan that retail investors are now buying Nasdaq/QQQ puts as likely hedges for the long cash equity positions!

On the other hand, and perhaps in response to the end of the Fed’s explicit end of backstopping IG/HY bonds, retail traders have shown a strong inclination to sell calls on HYG. Combined with JPM’s observation that HYG has seen net retail inflow YTD, it appears that buy-write on HYG could be a popular strategy with retail investors.

Finally, JPM’s Peng notes that the average implied volatility of the single names in Table 2 is also much higher than those in Table 1, which suggests that retail investors are generally buyers of calls on low-volatility names and sellers of calls on high-volatility names.

What are the implications?

From the anecdotal observations above, JPM sees some interesting interactions between retail flow on the options and on the  underlying equities. When systematically looking at the level of retail participation, retail market share to be around 40% correlated between the option and underlying equity market, based on JPM estimates.

But when the trade directions are taken into consideration, the relationship becomes weakly negative.

To JPMorgan, this could be due to the offsetting actions of two groups of investors: some investors use options as overlay on their long stock positions (e.g., covered call selling, protective put buying, etc.), whereas other investors use options as stock substitues (buy calls instead going long shares, buy puts instead of going short shares). The flows from the two groups offset each other and result in a net neutral relationship with underlying equities.

The bottom line is that retail investors, having suffered several bruising falls in their favorite basket of names, are learning how to trade like Wall Street’s top pros and hedging their profits by doing precisely what “hedge” funds do – not only going short the offsetting index pair trade, in the case of tech names that would be the QQQs, but doing so with substantial leverage.

And with retail traders massively outperforming both the S&P500 and HFR’s broadest hedge funds index…

… how long before investors start shunning the old “smart money” which has clearly been quite dumb in recent years, and shift their attention to the new hedgies? Because if retail investors are indeed starting to hedge out their winners even as hedge funds go all-in on their long books while unwinding their shorts…

… there seems to be a silent revolution taking place below the surface of the market, one where retail investors – formerly the dumbest money around – are set to not only trounce hedge funds but to also lock in gains in case of a major market swoon (i.e. “hedge”). How long, we wonder, before LPs – disgusted by years of underperformance – pull their money from the Bridgewaters of the world (whose risk parity fund has been a total disaster in recent years) and start allocating money to traders with names like “Roaring Kitty”?

Weeks after the administration previewed (via Bloomberg) its plans to push ahead with the first major federal tax hike since 1993 to fund its infrastructure ambitions, the first details of the Biden’s multitrillion-dollar infrastructure-climate plan have just been leaked via the New York Times.

Per the NYT, Biden’s economic advisers are preparing to recommend spending as much as $3 trillion on an “infrastructure” package that also features some facets of the Green New Deal, and other progressive measures to help “narrow economic inequality.” After months of debate and preparation, the Biden advisors are expected to present their proposal to the president this week. The plan reportedly recommends carving the administration’s economic agenda into separate legislative parcels, rather than trying to push through another leviathan like the stimulus bill (the battle over the “American Rescue Plan Act of 2021” passage seeped precious momentum from the administration as it struggled to deliver on its broad promises for the first 100 days).

The leak shouldn’t come as a surprise. Just last week, Goldman analysts warned that Biden’s upcoming boondoggle – his infrastructure plan – would outspend even the Dem’s unprecedented $1.9 trillion stimulus package. Goldman estimated that the final cost could be in the area of $4 trillion.

As it turns out, they weren’t far off. While the NYT put the size of the package at $3 trillion, that doesn’t include the cost of inequality-fighting tax cuts that could cost hundreds of billions of dollars, according to the draft documents leaked to the NYT’s Jim Tankersley.

The NYT cautioned that while these details remain in flux, the three-trillion price-tag showcases “the aggressive approach the Biden administration wants to take as it tries to harness the power of the federal government to narrow economic inequality, reduce the carbon emissions that drive climate change and improve American manufacturing and high-technology industries in an escalating battle with China and other foreign competitors.”

The package – which constitutes the first available details of the “Build Back Better” infrastructure plan promised at the outset of Biden’s administration – will represent a cornerstone of the Biden/Harris team’s eventual legacy.

Should the administration opt to move forward with the plan, broken up into more manageable chunks, the first legislative piece under discussion (which some Biden officials apparently consider more appealing to Republicans, business leaders and many “moderates” like Joe Manchin) would combine investments in manufacturing and advanced industries with what would be the most aggressive spending yet by the US to reduce carbon emissions and combat climate change.

It would spend heavily on infrastructure improvements, clean energy deployment and the development of other “high-growth industries of the future” like 5G telecommunications and the development of rural broadband networks to improve access to the Internet in (primarily red) states. Though according to the NYT, whether the bill can attract GOP support will largely depend on how it is paid for.

The second component of the package would focus on the country’s “human infrastructure,” according to the NYT.

The second plan under discussion is focused on what many progressives call the nation’s human infrastructure — students, workers and people left on the sidelines of the job market — according to documents and people familiar with the discussions. It would spend heavily on education and on programs meant to increase the participation of women in the labor force, by helping them balance work and caregiving. It includes free community college, universal pre-K education, a national paid leave program and efforts to reduce child care costs.

That plan would also make permanent two temporary provisions of Mr. Biden’s recent relief bill: expanded subsidies for low- and middle-income Americans to buy health insurance and tax credits aimed at cutting poverty, particularly for children.

Officials have weighed financing that plan through initiatives that would reduce federal spending by as much as $700 billion over a decade, like allowing Medicare to negotiate prescription drug costs with pharmaceutical companies. The officials have discussed further offsetting the spending increases by raising taxes on high-earning individuals and households, like raising the top marginal income tax rate to 39.6 percent from 37 percent.

Administration officials were still debating details of the tax increases late last week. One question is how, exactly, to apply Mr. Biden’s campaign promise that no one earning less than $400,000 a year would pay more in federal taxes under his plan. Currently, the top marginal income tax rate starts at just above $500,000 for individuals and above $600,000 for couples. Mr. Biden proposed raising that rate in the campaign.

Officials say they are committed to not raising the tax bills of any individual earning less than $400,000. But they have debated whether to lower the income threshold for the top marginal rate, to tax all individual income above $400,000 at 39.6 percent, in order to raise more revenue for his spending plans.

Mr. Biden’s broader economic agenda will face a more difficult road in Congress than his relief bill, which was financed entirely by federal borrowing and passed using a special parliamentary tactic with only Democratic votes. Mr. Biden could again attempt to use that same budget reconciliation process to pass a bill on party lines. But moderate Democrats in the Senate have insisted that the president engage Republicans on the next wave of economic legislation, and that the new spending be offset by tax increases.

As a team of analysts at JPM warned in a note to clients published earlier this month (and which we summarized here), Republican support will primarily depend on how Democrats choose to pay for it. GOP leaders like Mitch McConnell have already expressed opposition to any tax increases, while the Biden team has promised not to raise taxes on anybody earning less than $400K a year (whether that would work in practice, however, remains to be seen). Additionally, whether Democrats in the Senate choose to blow up the filibuster for bills could determine whether more progressive elements of Biden’s plan live, or die.

“The [bond market] selloff has largely run its course,” says Guggenheim CIO Scott Minerd, confirming his call from two weeks ago to ‘buy the dip’ in bonds as investors’ “reach for yield” puts downward pressure on 10-year Treasury rates, likely rendering the current yield unsustainable.

The bond market has had difficulty sustaining rates at or near the Fed’s neutral rate projection, and we see no reason to expect a different result this time. The selloff has largely run its course. https://t.co/m2RQTdfV7R pic.twitter.com/ysuDGOrd23

— Scott Minerd (@ScottMinerd) March 22, 2021

In fact, for foreigners, buying USTreasuries on an FX-hedged basis offers the biggest yield advantage over domestic sovereigns since 2014…

Source: Bloomberg

But, Guggenheim warns that “conflicting guidance” from Fed Chair Powell is potentially holding back bond investors.

Last week’s FOMC meeting showed that the Federal Reserve (Fed) intends to maintain rates at zero even when the economy overshoots traditional measures of full employment and price stability. But Fed Chair Jay Powell stopped short of pushing back on the bear steepening of the Treasury curve.

Powell is giving conflicting guidance to bond investors. Dovish forward guidance is bullish for the short end while the Fed’s efforts to lift inflation expectations have been bearish for the long end. The belly of the curve is caught in the middle.

The question investors face is whether the selloff has more room to run. Our analysis suggests it has largely run its course. The market is now pricing in a neutral rate of 2.35 percent, nearly in line with the Fed’s optimistic long run dots. The chart below shows that the bond market has had difficulty sustaining rates at or near the Fed’s neutral rate projection, and we see no reason to expect a different result this time. Nor do we expect the Fed to revise up its neutral rate estimate.

While the Fed has succeeded in lifting growth and inflation expectations, it now has a different problem: the market is pricing in premature rate hikes, as the chart below shows. The upshot for bond investors is that the steeper yield curve now offers an attractive carry and rolldown profile.

If the Fed is as patient as we expect it to be, total returns for core fixed income investors have the opportunity to be much better going forward than they have been in the recent past.