We “cannot overstate the movement overnight” is how Nomura’s cross-asset strategy MD, Charlie McElligott, begins his note to traders today, reflecting that the markets’ moves are “blistering.”
From a macro-perspective, McElligott notes that it certainly looks like the accumulating “real pain” of the escalating trade war (as indicated in “wrong way” global PMIs / US ISM ‘New Orders’ declines vs leap higher in ‘Prices Paid’ / lower U.S. corporate margins per Q3 EPS / survey data amongst others), and ultimately, the sensitivity of both U.S. and Chinese leadership to the optics of tanking stock markets (ESPECIALLY into mid-term Elections in the US) – has forced what he would call “movement,” with reports late last night saying that President Trump asking his cabinet to begin drafting potential terms of a trade deal.
However, just as we are skeptical (and reports suggest correctly), McElligott notes that the sequencing of events (recent US Equities selloff and timing of said Midterm Elections) has SOME viewing this as another “scheme” to ensure a U.S. stock market rally into the Elections to boost the Trump platform.
Additionally, McElligott points out that the rumor coming from Trump’s side also now “boxes-in” Xi as far as high expectations for an eventual deal – which can then too position him as the “fall guy” if the “deal” ultimately falls-through, especially with the incredibly-complicated 1) “Intellectual Property” forced-transfers- and 2) competitive advantages via subsidies for Chinese SOEs – issues at the core of the spat.
Nevertheless, the markets moves are blistering:
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Hang Seng closed +4.2% for its largest move since Nov 2011; HSCEI +4.0% for its largest move since Feb 2016; KOSDAQ +5.1% for its largest move since Sep 2011
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In Germany, Autos are again +3.8%; in Europe Consumer Durables are +3.4% and Banks are +2.4%
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The move in Yuan is jaw-dropping; the 2d move in CNY is now a -6.5 SD event back to the Chinese revaluation of Yuan / ending of the fixed Dollar peg in July 2005; CNH is seeing the 2nd largest 2d move since 2010 on capitulation from crowded shorts.
Separately, McElligott points out that the purported trade deal breakthrough came amidst two other “risk-bullish” catalysts:
- Another pledged upgrading of Chinese stimulus measures for the private sector from President Xi at an “unprecedented” symposium with business leaders on Thursday, including substantial tax cuts and bailout funds, “encouragement” of bank lending and an “ordering” of local governments to “rescue” troubled private sector firms.
- Reports that the U.S. is “said to” give 8 countries—including Japan, India and South Korea—oil waivers under the Iran sanctions to continuing buying their oil, in exchange for continued import cuts so as to not drive up oil prices—net / net a “growth lifeline” for Asian economies which need to import oil.
Incredibly lost in the all the bullish developments overnight was:
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Another hawkish impulse from the Bank of Japan, which again “stealth tapered” purchases in the 3y-5y JGB bucket – this too is part of the selloff in global Rates overnight, not just the “risk-on” news-flow alone.
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Similarly notable for the “Bearish Rates” trade per Darren Shames – BIG week-over-week decline in foreign custody holdings indicating UST liquidation flows, with the largest change since April and before that, Oct ‘16.
However, while mainstream business media heralds the gap-higher-opens and short-squeeze spikes as ‘wealth-enhancing’ for average joes everywhere (as if average joes were in the market), McElligott notes that these collective developments are potentially “soul-crushing” for Equities funds which have massively de-grossed / de-netted / de-beta’d their portfolio risk over the past month’s market calamity, literally low-ticking exposure in the period ahead of S&P Futures’ +6.2% rally since the Monday overnight lows:
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Street PB data showed that Tuesday was the largest day of Equities L/S “gross-down” in 3+ years, selling longs (in ‘most crowded’ Comm Services, Tech and Healthcare) and covering shorts (especially ETFs)
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Monday showed to be the largest underperformance in the top 10 ‘most crowded’ longs vs the SPX since 2010 on forced-deleveraging
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Again per Street PB data, both “gross-” and “net-” exposures @ ~ 2 year lows, with 5Y delta-adjusted “gross” just 25th %ile and 5y delta-adjusted “net” at just 9th %ile
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This speaks to my initial “point #1” a few weeks ago on the case for a re-risking move into Equities through year-end—that a “positioning-rinse” will PERVERSELY drive a violent mechanical “re-racking” of exposure from “first-mover” Systematic rules-based strategies, themselves too having de-risked throughout October (i.e. our CTA model showing “outright short” positions in SPX across 2w, 1m, 3m and 6m models through the end of the month)
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This “lunge higher” exposure rebuild was only able to develop after Macro funds (who have gotten the “bearish Rates” trade correct and thus had PNL to “play offense” with) were able to profit on downside Equities hedges – which meant YARDS of Equities delta to buy over the prior 48 hours – and quickly pivot into outright “upside” expressions through early Dec—painfully, all ahead of the fundamental universe, which are collectively licking their wounds and “frozen” with redemption concerns
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And thus my key observation over the past two notes: ULTIMATELY, the fundamental Equities community (both MF and HF L/S) is now a massive “synthetic” short-gamma in the Equities-space, turning forced-buyers the higher the tape goes—and as expensive as options have become after last month, this means outright “spastic grabbing” of index futures and ETFs in an attempt to rebuild any semblance of exposure to this explosive gap-move higher
On a related note, McElligott warns that indications are that redemption flows and “unwind-y behavior” continues in the quant strategies universe…
VERY CONCERNING cross-asset “Momentum Reversal” price-action in the most-crowded CTA-Trend positions yesterday, which could very reasonably be interpreted as REDEMPTION-related with proxy trackers of industry performance anywhere -6% to -15% YTD now
These strategies again proving to be more susceptible to “crowding risk” than their “risk diversification” marketing claims, as the market regime shift’s ”rolling vol events” chops their “calm-dependent” strategies
Yesterday’s most obvious “Max” position liquidation candidates:
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All “long USD” tied trades were nuked, as our model showed recent re-accumulation of “Max Shorts” URUSD, GBPUSD, AUDUSD and NZDUSD / “Max Longs” in USDJPY, USDCAD, USDCHF, USDNOK, USDSEK, USDCNH which all traded violently “backwards” yesterday
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Gold and Metals (both precious and industrial) had recently again moved-back to “Max Short” status, but yesterday and again today continue squeezing powerfully higher (Gold a +3SD move yday, while the 2d move in Industrial Metals is a +2.5SD move relative to past year’s returns)
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“Max Long” in Brent Crude being destroyed, with the prior 4d move a collective -2.5SD drawdown
Additional assets “at risk” going-forward from CTA redemption flow:
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MAX SHORTS in Eurostoxx, DAX, CAC40, Hang Seng, HSCEI, ASX, Kospi, Nikkei; EUR / JPY / GBP/ AUD / CAD / NZD / NOK / SEK / CNH; ITA 10Y; Industrial Metals, Precious Metals
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MAX LONGS in Brent Crude; EUR 10Y, JPY 10Y, GBP 10Y, AUD 10Y, CHF 10Y, FRA 10Y
And remember when in my mid-June structural / trading behavior “Downshift” note, where the macro regime shift from “Cyclical Melt-Up” into the much more difficult “Financial Conditions Tightening Tantrum” meant that the trading environment too would then transition from a period of “high Sharpe” directional trades to instead a hyper-tactical stance, with called for monthly “mean reversion” trades / hedges? Well….yesterday exemplified that perfectly within the Equities quant space, with widespread “stress” apparent–
Yesterday’s U.S. Equities factor-behavior was indicative of “stress” as well – as we have discussed to pain seen in some high profile “quants” YTD:
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“1m Price Reversal” factor finished +3.5% for its largest move since Nov ‘17 and now +7.0% QTD; the return was almost entirely from this month’s “Reversal Longs,” meaning that the largest “losers” of last month’s capitulation via de-gross, de-net and tax-loss selling were the biggest “winners” yesterday
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“1Y Momentum” was crushed -2.5% on the session, its 10th ~-2SD move since late June
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Recently defenestrated “Beta” and “Volatility” exploded higher, +2.5% / +3.6% on the day respectively—largest 2d positive move in “Beta” (+5.5%) since the U.S. Election, largest 3d move in “Vol” (+7.7%) since March ‘16
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“Size” factor (small cap over large) saw a +3.6 SD move, largest since Nov ‘16
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“R&D / EV” factor sees a +3.1SD move, largest since April ‘16
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“Conditional Reversal” factor sees its 5th largest move in its history
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“Default Risk” factor largest move since Nov ‘16
As we noted previously, volatility is not going away as this stress, de-risking, and re-rising panic is far from over.
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