Thoughts From JPMorgan Futures Trader: “Any Rally Feels Fairly Unsustainable”

Some macro thoughts from JPMorgan futures and options trader Marissa Gitler.

After a handful recent conversations, the most salient theme from clients has been a lack of conviction as for how to handle the next few months of trading. What’s interesting is that the general thought process amongst many remains the same – EPS and company guidance are likely to fall short of articulated expectation in Q3 as inflation has failed to moderate globally while growth has definitively started to wane in lockstep.

The FED will continue hiking to keep inflation under control in the short term, though much is out of their devices as energy, input prices, and supply chain bottlenecks outpace demand-led triggers in the market. Inflation will eventually start to moderate into the back half of the year (though still remain higher than ‘target normal’). Recession in the US isn’t a guarantee, but the likelihood is increasing – whereas Europe’s outlook is much more bleak and headed towards stagflation given inflation pressures are more heavily tilted towards the supply-side. Though emerging market economies have, in past, been better equipped to weather an inflationary storm – they are currently fairly anchored to the path of DM rates, and overall performance of DM countries (from a demand perspective), and (though to a bit lesser extent now) China. Energy upside makes sense fundamentally (inventories remain critically low), but desire to add to existing positioning is lacking at current elevated levels amidst lower liquidity, higher realized vol, and recession fears ticking higher. Similar can be said for Ags, which are broadly back to pre-invasion levels as positioning while wiped out in the broader macro sell-off.

As per this thought process, risky assets continue to look fairly unattractive, while the popular front-end fixed income shorts that had ‘worked’ for the majority of the year now appear at more risk. Though the US outlook is better than most from a global perspective – a U.S. flight-to-quality trade fails as the FED path remains uncertain (highly inflation-print dependent) while equity valuations still appear stretched in the current macro environment.

Consequently, investors have continued a pattern of degrossing in the equity space – from both the long and short sides. As has been well advertised at this point, CTAs were the first to de-gross when indexes crossed through technical downside levels, while long only’s have been working through books to take down exposures throughout the entirety of 2022. Though selling of growth plays by long-only’s has been taking place since the end of last year when yields began to move decidedly higher, the newest iteration of selling has been of well-owned winners (like Energy) as there remains overall less of the growthier/weak balance-sheet stocks to sell. Moreover, HFs – who had most recently been playing the market from the short side on the back of global central banks’ sharp hawkish pivot, have also taken down grosses ahead of the summer; covering short positions at the index lows, and unwinding index hedges given there is a higher bar for a further rollover (recession) vs a move higher (squeeze/chase).

The question really becomes – how to go forward amongst what has now become fairly homogeneous (under-positioned) playbook and recession-led thought process amongst investors; especially as we enter the historically more ‘relaxed’ summer months. As the market awaits more information (eco data, inflation prints, CB rhetoric) there has been a fairly well advertised upside equity rebalancing view into month end – which has caused many macro investors to step back from selling at the index level in recent days. Moreover, there are worries arising that a drift higher will trigger CTAs to re-enter the market, which would then spiral into price moves higher given the reduced overall positioning. In the same vein, discussions of market bottoms preceding actual recessions have also begun to enter conversations. Any pullback in bond yields would also add to this conversation.

The tactical upside play appears to me a bit of a shaky leg to stand on longer term, especially as the macro environment is far from decisive in its path forward, and index hedges have come down over recent weeks (which could lead to more violent down-trades). For those looking into upside in the next few months – would be best to play tactically from a positioning perspective – long in what is under-owned (growth/tech/short momentum), and balancing these trades scaling into some long-duration plays. Overall though, I still favor using equity upside as opportunity to re-engage in sales. What I continue to watch for (in equities), is growth in open interest (and net position growth by asset managers in CFTC data) that would imply CTA re-engagement and real money equity re-grossing – which would provide footing for a more sustained move higher – but this is yet to be seen…

Bottom Line: light positioning could lead to an equity rally, but in absence of CTA re-engagement this feels fairly unsustainable, play any upside tactically – vol has cheapened, puts are attractive for short-term downside delta plays.