After the furious move in the market in the past two days, numerous theories have already sprung up seeking to explain the sharp reversal in the downward risk pressure observed through most of October, with some speculating that the macro data is finally turning, that China is getting more aggressive in backstopping its capital markets, that underwater hedge funds are scrambling to load up on high beta names in a last-minute rush to catch up with the market, or that the selling pressure has simply been exhausted.
While all those may have some validity, they all try to goalseek the price action with some grand unifying narrative.
As to what is really happening, we go to Morgan Stanley’s Equity Derivatives team, which in a note released moments ago provides a startling answer: yesterday’s move was nothing but another furious short squeeze, to wit:
Worryingly the strength in US markets appears to be driven by a squeeze in the shorts, rather than a true “risk on” redeployment of capital. My colleagues in the US noting today that their basket (MSXXSHRT) outperformed meaningfully again today, the second largest one day relative move since 2016 – the largest move was Tuesday!
That’s for the US; there was some better news out of Europe where the move appears to have been more organic:
We just published an update on the short covering we are seeing in Europe and our recommendations for our baskets (MSSTHISI, MSSTARSI). In a nutshell the short covering we already saw throughout Jun-Aug, coupled with the comfortable p&l cushion, has ensured that short-covering is NOT driving European markets.
The lack of a squeeze also explains Europe’s modest bounce today:
After the October we just survived, I suppose it comes as no surprise that November kicked off with more of a whimper than a bang, as Eurostoxx50 closed up a mere 20bps. Despite this almost zero realised day, intraday gamma continues to offer staggering value (10d hi-lo realised sits ~26v, still around the Feb highs). This is in part driven by the “aimless” type trading on light volumes we see in our early morning sessions, as traders hold out to take our direction from US earnings and investor behaviour. It’s also certainly impacted by this incredibly distracting headline tennis on the potential escalation or de-escalation of trade wars.
Finally, Morgan Stanley’s quants have an interesting trade idea:
another fantastic update note from Rob & team looking at our favourite “End of QE” trade – short/long puts on MSSTWKBS Index. Ask us for a call.
- All stocks rated BBB or worse, massive debt roll-over in next 3Y, issuance of credit expanding + quality of credit deteriorating.
- The HF long book is unwinding, the short book can rise.
- Theme outperformed in sell-off so great opportunity for shorts to re-engage in preparation for QE ending.
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