It's "Groundhog Day" again… again, scoffs RBC's head of cross-aset strategy Charlie McElligott in his latest note. For the sake of clarity, he keeps it short and sweet…
> ‘Macro range trade’ persists – sell ‘reflation’ at 2.40 in UST 10Y yields, buy ‘reflation’ at 2.15.
> Investor muscle memory remains ‘buy risk- & carry- dips / sell vol rips’ as PMIs & ISM remain ‘expansive’ alongside ‘goldilocks’ US rates / US Dollar for corporates.
> That said, rates are currently unable to hit ‘escape velocity’ due to breakdown in ‘inflation expectations’ via the trifecta of ‘Tightening Fed’ / ‘Deleveraging China’ / ‘Less-Dovish ECB’ in conjunction with the fading energy ‘base-effect’.
> This 1) ‘disinflationary impulse’ alongside 2) slowing trajectory of US economic data vs R.O.W. (all G10 stronger against USD over the past wk) 3) fading expectations of US fiscal policy are contributing to the meltdown in USD, lower US nominal yields (think ‘anchoring’ rates) and flattening UST curves.
> The implications of these ‘perpetually easy’ US rates / Dollar conditions for equities continue to be clear:
1. Large institutional / passive inflows into equities ‘buying the dip,’ as we now see new YTD highs in the cumulative NYSE market-on-close buy imbalances
2. More ‘vol selling’ in the market as evidenced by large overwriting programs across multiple sectors in recent days, with clients selling options to collect premium in core long names on expectations for a placid market backdrop over next few months / predictable Fed @ June mtg
3. The ratio of ‘Growth’ factor (‘secular’ stories with EPS / revenue growth and little policy- / rate- exposure) to ‘Value’ (metrics including ‘book or earnings to price’ / ‘book value’–largely cyclicals with rates- and policy- sensitivity) now sits at 17 year highs;
4. ‘Quality’ (ROE, earnings stability, div growth stability) now massively outperforming ‘Size’ (small cap, more cyclically-geared companies), with the ratio at highs last seen during the 1Q16 market and before that, 4Q11
5. ‘Anti-Beta’ now the 2nd best performing US factor market-neutral strategy YTD on the aforementioned inability for rates to move higher (and investor preference for yield / ‘low volatility’ of bond-like equities)
‘Growth : Value,’ ‘Quality : Size’ and ‘Anti-Beta’ market neutral are all expressions of ‘defensive’ investor positioning as it relates to ‘low’ / ‘stable’ future expectations for the US economy—which corroborates with aforementioned flat curves and low nominals.
Specifically as it relates to the ongoing defenestration of ‘Value,’ we continue to see signs of market-neutral book unwinds in both ‘energy’ and ‘financials’ sectors where the ‘tight stops’ model can’t handle ‘acute’ one-way melt-downs (alongside flailing stat-arb ‘mean reversion strategies QTD).
As I have stated since late March though—this incredible ‘one-way crowding’ into ‘Growth’ proxies (tech, consumer discretionary, biotech) corroborated by 13F’s and FAANG / PANE / sector performance evidences a major market positioning asymmetry, as well as ‘over-exposure’ to ‘market’ factor risk (a.k.a. long books are very ‘high beta’) which could ‘tip over’.
The largest market risk to me isn’t thus a ‘systemic’ or economic one; it is a ‘systematic’ one (‘get it’?)
This is essentially a ‘pure Minsky’ backdrop, where due to ‘epic’ lows in cross-asset realized vols (per the inability of monpol to sustain ‘inflation expectations’—and thus rates—higher), ‘negative convexity’ / ‘short gamma’ strategies continue to allocate large leverage / exposure onto traditionally ‘risky’ assets to generate return
For example, CTA and risk-parity length in equities or EM bonds / FX; equity L/S gross- and net- leverage at cycle-highs; or ‘vol risk premia’ funds profiting from CB liquidity; or more ‘micro,’ market-neutral equities strats which have been required to load increasing amounts of leverage upon ‘working’ factor strategies to amplify returns
Classic ‘pennies in front of a stream-roller’ / ‘negative skew’ return profile – Taleb distribution: “The statistical profile of an investment which normally provides a payoff of small positive returns, while carrying a small but significant risk of catastrophic losses.”
The problem is….IT KEEPS WORKING, because market expectations for rates / curves / inflation expectations remain D.O.A., which perversely keeps the major global central banks “reflexively easy”—a.k.a. “The Insanity Loop”
Punchline: we need sustained and regularly-occurring rate hikes to break the lazy-carry complacency, which in turn will allow for macro trading regime change.
STALL-SPEED—IS THE BEST NOW BEHIND US?
‘VALUE’ DESTROYED RELATIVE TO ‘GROWTH’ AS PERPETUALLY ‘EASY’ POLICY SINCE ’09 KEEPS RATES LOWER / CURVES FLATTER:
RATES THAT DON’T RISE / CURVES THAT DON’T STEEPEN = ‘GOLDILOCKS’ FOR LEVERAGED-ALLOCATION / VOL-TARGETING / RISK-PARITY / ‘CARRY’ STRATEGIES (% RETURN YTD):
via http://ift.tt/2rMMDGx Tyler Durden