iftttwall

Earlier today we reported that based on various internal metrics, the market-neutral quant space is suffering one of the most violent deleveraging episodes since the infamous quant blow up in August 2007.

But what is really going on below the surface to force these dramatic moves which may not seem like much to the untrained eye, but to PMs managing 10x levered market neutral funds are earthshattering. For the answer we go to the head of US cash trading at RBC, Charlie McElligott, who has given the most succint explanation yet.

Big Picture: HF Positioning/13Fs/Macro Unwinds

• Another macro trade reversal today, with stocks / crude / EM / HY sharply higher, against USTs / bunds / EDs / vol lower,  as we see a ‘risk-ON’ pivot from an under-positioned / over-cashed market.
• Taking this a step further, ‘micro’ within stocks shows further market-neutral and long-short ‘lunging,’ which is of course predicating on extremely ill-timed / wrong-footed ‘grossing-up’ of short books, while net exposure was cut to multi-year lows (via selling longs).  All of this of course, into the teeth of a 100+ point face-ripper in Spooz.  

Currently today shows approx. 100 to 150bps of short book proxy outperformance vs index, and about 100 to 150bps of outperformance versus ‘favorite long’ proxies—almost a mirror-image of yesterday/ See the monitor:

As a matter of fact, MS PB data shows that Tuesday was the largest cover day since Oct 2014, driven by both fundamental accounts AND quants.  Which segues nicely into the next point

As highlighted last night in the special post-close version of “RBC Big Picture,” the extent of the recent equity market-neutral deleveraging (and concurrent pnl destruction) is on par with the US debt downgrade / Lehman / Bear trades.  Again a repeat from last night’s piece but this returns histogram captures it perfectly:

When you see multiple periods of -1% returns consecutively, against AUM leveraged at 10 to 14x’s, the sheer enormity of notional $$$’s plowing ‘into’ shorts on covers and ‘out of’ longs is insanely huge, and dwarfs other flows.  Thus, the general violence of these extreme moves—these market forces are not just huge, but due to the nature of many of the equity quant models being derived from the same ‘core’ theses, the amplification / ‘echo’ of these books sees inherent ‘crowding’ / ‘herding.’

13Fs: Q4 filings showing the extent of the hedge fund wide destruction.  Look at the positioning into start of ‘16, per the most heavily weighted Q4 sectors / allocations–Financials at 21.2%, Info Tech at 20.1%, Consumer Discretionary at 16.8% and Health Care at 13.2%:

Now, look at the S&P worst performing sectors YTD—Cons Disc, Info Tech, Health Care and Fins:

THE HUMANITY.  Obviously, this goes hand-in-hand with the points above on the extent of the performance-pain, dragging down all equities players.
 
Turning to another equities tailwind, how about the $22B of US IG issuance unleashed yesterday?!  For context, it was the second largest day off paper YTD.  This is most notable for the equities crowd not just because it shows money being ‘put to work,’ but becausethe majority of that debt was ear-marked for stock repurchases (AAPL, IBM).   GS data is showing us that YTD buyback announcements are off to their strongest start ever at $132B—last week alone saw 47 new BBs totaling $42B authorized. 
 
Piling-onto the squeeze-theme is the ‘turn’ in CTA / managed futures positioning: price momentum has shifted in SPX, crude and USTs / EDs, and need be monitored for further break-out.  This certainly would add considerable fuel to the equities melt-up, as remember, being ‘price insensitive’ goes both-ways…but can also add to performance-issues, with much of that stock short base still built via Energy, Industrials and Materials.  Ouch.
 
Also worth noting, Atlanta Fed Q1 GDP tracker today is at +2.7% (up from 0.7% in January).  This ‘growthier’ move could definitely catch those who have positioned for disinflation /deflation or the dreaded recession AWFULLY upside-down.

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Federal Reserve officials are split into two camps, according to Wall Street Journal’s Jon Hilsenrath, those who believed that risks to the economy were materializing and those who wanted to wait and see. Either way, The Fed is confused and their 4-hikes in 2016 meme is disappearing fast.

As The Wall Street Journal reports,

Federal Reserve officials struggled with uncertainty about the outlook for inflation and growth at their January policy meeting —and whether rising risks to the economy might alter their plans to raise short-term interest rates.

 

Declining stock and oil prices, doubts about China, indications of declining inflation expectations in markets and other factors left officials split in two camps—those who believed that risks to the economy were materializing and those who wanted to wait and see.

 

“Participants judged that the overall implication of these developments for the outlook for domestic economic activity was unclear, but they agreed that uncertainty had increased, and many saw these developments as increasing the downside risks to the outlook,” the Fed said in minutes of the Jan. 26-27 policy meeting, which were released Wednesday with their regular three-week lag.

This seems to confirm what we already noted as the best summary of this farce…

FOMC Minutes: The Fed didn’t provide an economic assessment in January because they’re as puzzled as all of you.

— Binyamin Appelbaum (@BCAppelbaum) February 17, 2016

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Since the January FOMC statement, Janet has spoken twice and what seems like every Fed speaker has hit the headlines to explain their decisions (only to confuse the market more) leaving bonds and gold outperforming amid their clear confusion. The Minutes appear to confirm that confusion:

• *FOMC MEMBERS AGREED DATA TOO UNCLEAR TO GAUGE RISKS TO OUTLOOK (confused)
• *FED OFFICIALS CONTINUED TO EXPECT GRADUAL POLICY TIGHTENING (hawkish)
• *MANY FED OFFICIALS AT JAN. FOMC SAW INCREASED DOWNSIDE RISKS (dovish)

So The Fed was unanimous in its decision to leave rates unchanged, downgraded the economic outlook, and was fearful of the global financial volatility – which in the last 3 days has all been solved.

Stocks just managed to get back into the green since the January FOMC statement but bonds and bullion lead…

 

Further headlines:

• *A NUMBER OF FED OFFICIALS CONCERNED BY DRAG ON U.S. FROM CHINA (but you said it was irrelevent)
• *FED: OIL, USD LIKELY TO HOLD DOWN INFLATION FOR LONGER
• *MOST FED OFFICIALS SAW MODERATE U.S. GROWTH
• *FED OFFICIALS CONTINUED TO EXPECT GRADUAL POLICY TIGHTENING
• *FED OFFICIALS STRESSED TIMING AND PACE WOULD DEPEND ON DATA

Here are the key sections. On uncertainty and downside risks:

The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff’s as-sessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks; the downside risks to the forecast of economic activity were seen as more pronounced than in December, mainly reflecting the greater uncertainty about global economic prospects and the financial mar-ket turbulence in the United States and abroad.

On employment:

Consistent with the downside risk to aggregate demand, the staff viewed the risks to its outlook for the unemploy-ment rate as skewed to the upside.

On wage pressures:

In their comments on labor market conditions, participants cited strong employment gains, low levels of unemployment in their Districts, reports of shortages of workers in var-ious industries, or firming in wage increases. Most an-ticipated that employment would expand at a solid rate over the year ahead, although several saw the prospect of some moderation in employment gains from the par-ticularly large increases in the fourth quarter of 2015.

On inflation:

The risks to the projection for inflation were seen as weighted to the downside, reflecting the possibility that longer-term inflation expectations may have edged down and that the foreign exchange value of the dollar could rise substantially fur-ther, which would put downward pressure on inflation.

On China, which if you will recall the Fed spent most of 2015 assuring anyone who listened would not be a risk factor:

Regarding the foreign economic outlook, it was noted that the slowdown in China’s industrial sector and the decline in global commodity prices could restrain eco-nomic activity in the EMEs and other commodity- producing countries for some time. Participants dis-cussed recent developments in China, including the pos-sibility that structural changes and financial imbalances in the Chinese economy might lead to a sharper deceler-ation in economic growth in that country than was gen-erally anticipated. Such a downshift, if it occurred, could increase the economic and financial stresses on other EMEs and on commodity producers, including Canada and Mexico. Moreover, global financial markets could continue to be affected by uncertainty about China’s ex-change rate regime. While the exposure of the United States to the Chinese economy through direct trade ties was limited, a number of participants were concerned about the potential drag on the U.S. economy from the broader effects of a greater-than-expected slowdown in China and other EMEs.

On financial conditions:

Domestic financial conditions tightened over the inter-meeting period, as turmoil in Chinese financial markets and lower oil prices contributed to concerns about prospects for global economic growth and a pullback from risky assets. The increased reluctance to hold risky assets was associated with a sharp decline in equity prices and a notable widening in risk spreads on corporate bonds. Treasury yields declined across maturities, reflecting a downward revision in the expected path of the federal funds rate and likely some increase in safe-haven de-mands amid the market turbulence. The dollar appreci-ated against most foreign currencies.

On markets:

Broad U.S. equity price indexes declined sharply over the intermeeting period, exhibiting a high correlation with movements in crude oil prices and foreign equity in-dexes. Domestic equity indexes were quite volatile in January, and one-month-ahead option-implied volatility on the S&P 500 index climbed to the upper end of its range of the past few years. Spreads on corporate bonds over comparable-maturity Treasury securities widened over the intermeeting period, reportedly reflecting in-creased concerns about corporate credit quality, particu-larly in the energy sector, and a decline in investors’ will-ingness to assume risk.

* * *

A quick take by Bloomberg,

Federal Reserve policy makers debating their outlook for interest rates last month expressed concern that the fall in commodity prices and the rout in financial markets increasingly posed risks to the U.S. economy.

 

“Participants judged that the overall implications of these developments for the outlook for domestic economic activity was unclear but they agreed that uncertainty had increased,” according to minutes of the Federal Open Market Committee’s Jan. 26-27 meeting released Wednesday in Washington. “Many saw these developments as increasing the downside risks to the outlook.”

 

Policy makers, who projected in December that they’d raise interest rates four times this year, are grappling with the fallout of market turbulence that has cast doubt over the economic outlook globally. Fed Chair Janet Yellen suggested in congressional testimony last week that the central bank could delay its plans for tighter policy to assess how the economy reacts to current headwinds.

 

The minutes go into more detail than the FOMC’s statement on policy makers’ concerns about the risks to the U.S. economy. While voting members “generally agreed” they couldn’t assess the balance of risks to the outlook in the statement, officials “observed that if the recent tightening of global financial conditions was sustained, it could be a factor amplifying downside risks,” according to the report.

 

Another part of the minutes indicated that a minority of policy makers judged that recent developments had “increased the level of downside risks or that the risks were no longer balanced.”

To sum it all up…

FOMC Minutes: The Fed didn't provide an economic assessment in January because they're as puzzled as all of you.

— Binyamin Appelbaum (@BCAppelbaum) February 17, 2016

The full minutes below (link):

via Zero Hedge http://ift.tt/1Ws1JcO Tyler Durden

Submitted by Claire Bernish via TheAntiMedia.org,

Though fracking industry proponents scoff at any intimation their so-called vital industry poses even scant risks to the public, a new study published in Toxicology and Applied Pharmacology just proved those critics right — fracking wastewater causes cancer.

Using human bronchial epithelial cells, which are commonly used to measure the carcinogenesis of toxicants, researchers confirmed fracking flowback water from the Marcellus Shale caused the formation of malignancies.

After conducting further tests on live mammalian subjects, researchers found five of six mice “injected with cells transformed from well water treatments developed tumors as early as 3 months after injection,” including a tumor in one mouse that grew to over 1 cm in size in just five months. A control group did not develop any tumors for the six months of the study period.

According to the study, performed by scientists from the Department of Environmental Medicine, as well as Biochemistry and Molecular Pharmaceutical at New York University, the Robert Wood Johnson Medical School at Rutgers, and esteemed partners from universities in China — results indicate fracking flowback water causes cancer.

Implications of the report’s findings would be difficult to overstate considering how fracking wastewater is generated, stored, and treated, and how often spills, leaks — and even the wastewater injection process, itself — can lead to contamination of the potable supply. A concise but thorough explanation of the fracking process can be found in the introduction to the report, “Malignant human cell transformation of Marcellus Shale gas drilling flow back water,” which states:

“Natural gas is believed to possibly be a bridge to transitioning from coal dependence. Currently natural gas fuels nearly 40% of the U.S. electricity generation, and the Marcellus Shale formation in the Appalachian Basin is on the forefront of gas-shale drilling for natural gas production in the United States. Mining natural gas is not new, but the volume has soared in recent years because the new technique of high-volume horizontal hydraulic fracturing (HVHHF). The concern surrounding the environmental, public health, and social impacts of this method has increased accordingly. HVHHF is an advanced technology that injects water, sand, and other ingredients at very high pressure vertically into a well about 6000 to 10,000 feet deep. The high pressure creates fractures in the rock that extend out as far as 1000 ft away from the well. The pressure is reduced after the fractures are created, which allows water from the well to return to the surface, also known as flow back water [or flowback]. The flow back water contains complex proprietary chemical mixtures, but also naturally occurring toxins such as metals, volatile organics, and radioactive compounds that are destabilized during gas extraction. On average, 5.5 million gallons of water is used … to hydraulically fracture each shale gas well, and 30% to 70% of the volume returns as flow back water.”

 

Options for dealing with this flowback are somewhat limited. The report continues:

“Currently discharge options of flow back water are: inject underground through an onsite or offsite disposal well; discharge to a nearby surface water body; transport to a municipal wastewater treatment plant or publicly owned treatment works;” or other treatment, transport, and/or reuse options.

But concerns about the contents and impacts of wastewater are the reason researchers studied its effects:

“Metal pollution is a serious problem as they are taken up readily in the digestive tract and exhibit harmful effects on many tissues. Barium and strontium are abundant in the Marcellus Shale formation, and are easily dissolved and transported in wastewater after gas drilling activity, which could potentially pose a threat to drinking water.”

In fact, in 2014, environmental consulting firm Downstream Strategies diligently attempted to track fracking water from Marcellus Shale drilling — both water withdrawn from sources for use in the process, as well as wastewater — but found it to be a nearly impossible task.

“We just couldn’t do it,” said staff scientist Meghan Betcher, according to Yale’s e360.

Regulatory requirements that would otherwise divulge where these massive quantities of water end up are simply not in place. According to the Downstream Strategies study, “gas companies use up to 4.3 million gallons of clean water to frack a single well,” and “more than half of the wastewater is treated and discharged into surface waters such as rivers and streams.”

Additionally, in 2013, Duke University geochemists published a study that found “dangerous levels of radioactivity and salinity at a fracking disposal site near Blacklick Creek, which feeds into water sources for Pittsburgh and other western Pennsylvania cities.” Even more disturbingly, after studying soil samples for two years, between 2010 and 2012, “After wastewater was treated at the plant to remove dangerous chemicals, radiation was detected far above regulated levels.”

“Each day, oil and gas producers generate 2 billion gallons of wastewater,” Duke Professor Rob Jackson stated, as Business Insider reported. Though the disposal site near Blacklick Creek has since ostensibly agreed to stop storing or treating Marcellus Shale fracking waste, the industry is far from clean — or transparent.

“They produce more wastewater than hydrocarbons,” said Jackson of the natural gas industry. “That’s the broader implication of [the Duke] study. We have to do something with this wastewater.”

Considering the Marcellus Shale study and the now-proven cancer link, fracking wastewater just became enormously important to millions of people living near thousands of wells in the United States, as well as other countries.

As the Downstream Strategies researchers found, due to lack of regulatory reporting requirements for the fracking industry — aided greatly by its exemption from the Safe Drinking Water Act by law in 2005 — “the fate of 62 percent of fracking waste is unknown.”

Researchers for the carcinogenicity study of flowback claim progress with their findings, identifying barium and strontium as traceable fracking contaminates, which they say should now be designated for further study. As the study concludes:

“Research to determine whether fracking-associated pollutants can migrate to private or public drinking wells, to identify early warning indicators of exposure and effect, and to identify suitable remediation approaches are urgently needed.”

via Zero Hedge http://ift.tt/1Xy4bj6 Tyler Durden

Yesterday, when summarizing the latest torrid move in stocks higher, we said that stocks surged ‘on the biggest short-squeeze in 4 months.”

 

Today, Credit Suisse picks up on this theme and asks “how much of this rally is short covering?” The bank’s answer: “Looks like a lot based on this prime services data.”

CS adds that: “today, several short baskets outperforming; Materials by 120 bps, energy by 80 bps, consumer discretionary by 50 bps, telcos by 37 bps, healthcare by 25 bps, info tech by 20 bps.  Goldman most short rolling basket up 4%.  Lot of the lower quality high levered names outperforming at the expense of the higher quality more widely owned names.”

 

How much of this squeeze is spilling over into the market neutral quant fund world, and leading to one of the biggest dislocations and deleveragings observed since August 2007 as noted earlier?

It is unclear as of this moment, however once the dust settles we expect to see some rather prominent names getting badly hit on the last three days’ move.

via Zero Hedge http://ift.tt/1VnKysF Tyler Durden

For equity market-neutral funds, there is a phrase more chilling than "worst since Lehman" and that is the quant meltdown in "August 2007" that put many funds out of business. While the mainstream media remains focused elsewhere, the last two weeks have seen equity market-neutral funds 'crash' (and today it is getting worse) as momentum factors diverge and memories of the 2007 bloodbath come back… as this forced unwind drives the current ramp.

As detailed at the time, during the week of August 6, 2007, a number of high-profile and highly successful quantitative long/short equity hedge funds experienced unprecedented losses.

The losses at the time were initiated by the rapid unwinding of one or more sizable quantitative equity market-neutral portfolios.

 

Given the speed and price impact with which this occurred, it was likely the result of a sudden liquidation by a multi-strategy fund or proprietary-trading desk, possibly due to margin calls or a risk reduction.

 

These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses on August 9th by triggering stop-loss and de-leveraging policies.

It appears more than one quant fund is unwinding…

We have been explicitly focused on the HFRXEMN – hedge fund equity market-neutral fund index – since April 2009, warning at the time that the increasingly self-confirming equity trading community was, ultimately, an unsustainable and fragile condition…

As more and more quants focus on trading exclusively with themselves, and the slow and vanilla money piggy backs to low-vol market swings, the aberrations become self-fulfilling. What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme. As the overall market volume is substantially lower now than it has been in the recent past, this strategy has in fact been working and will likely continue to do so… until it fails and we witness a repeat of the August 2007 quant failure events… at which point the market, just like Madoff, will become the emperor revealing its utter lack of clothing.

 

So what happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible: large swings on low volume, massive bid-offer spreads, huge trading costs, inability to clear and numerous failed trades. When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility. Furthermore, high convexity names such as double and triple negative ETFs, which are massively disbalanced with regard to underlying values after recent trading patterns, will see shifts which will make the current crude oil swings seem like child's play.

 

…

 

So when will all this occur? The quant trader we spoke to would not commit himself to any specific time frame but offered a list of possible harbingers: continued deleveraging in quant funds as per the charts noted above, significant pre-market volatility swings as quants rebalance their end of day positions, and ongoing index VWAP dislocations.

 

One thing is for certain: the longer the divergence between real volume trading/liquidity and absolute market changes persists, the more memorable the ensuing market liquidity event will be. At the end of the day, despite the pronouncements by the administration and more and more sell-side analysts that the market is merely chasing the rebound in fundamentals in what has all of a sudden become a V-shaped recovery, the "rally" could simply be explained by technical factor driven capital-liquidity aberrations, which will continue at most for mere weeks if not days.

While quant funds have many factors and many styles, one of the most popular in recent years has been 'Momentum'.

Momentum-trading is the magic-sauce that makes a genius out of every trader in a bull market. The last few years have seen 'strong' momentum stocks drastically outperform 'weak' momentum stocks. However, the last 5 weeks have seen the biggest unwind of this trade since records began… as it is clear that equity market-neutral funds models are blowing up and they are liquidating…

 

And the last 3 days have ravaged it even more as the squeeze bounce has sent every Tom, Dick, and Day-trader piling into the worst of the worst momentum stocks…

 

So while the ramp of the last few days feels great from a headline index perspective, not only is it a squeeze of the "most shorted" stocks but a forced liquidation unwind of Momentum Long/Short funds (i.e. buying back the weakest momo names) has exaggerated the rally. Sooner or later, if this continues, as in Aug 2007, the selling pressure (and liquidity suckout) will systemically weigh on all names.

Charts: Bloomberg

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For the second time in four months, S&P has downgraded Saudi Arabia. 

In late October, the ratings agency flagged sharply lower oil prices and the attendant fiscal deficit (16% in 2015) on the way to cutting the kingdom to A+ outlook negative. 

At the time, S&P projected the deficit would amount to 10% of GDP in 2016. That turned out to be optimistic as the shortfall is now projected to be around 13% and that’s assuming crude doesn’t fall below $30 and stay there. 

Riyadh has cut subsidies in an effort to shore up the books, but between the war in Yemen and defending the riyal peg, there’s no stopping the red ink, especially not while the kingdom remains determined to wage a war of attrition with the US shale complex.

Moments ago, S&P downgraded Saudi Arabia again, to A-.

On the bright side, the outlook is now “stable” (chuckle).

*  *  *

From S&P

Oil prices have fallen further since our last review of Saudi Arabia in October 2015, and we have cut our oil price assumptions for 2016-2019 by about $20 per barrel. In our view, the decline in oil prices will have a  marked and lasting impact on Saudi Arabia’s fiscal and economic indicators given its high dependence on oil.

We now expect that Saudi Arabia’s growth in real per capita GDP will fall below that of peers and project that the annual average increase in the government’s debt burden could exceed 7% of GDP in 2016-2019.

We are therefore lowering our foreign- and local-currency sovereign creditratings on Saudi Arabia to ‘A-/A-2’ from ‘A+/A-1’.

The stable outlook reflects our expectation that the Saudi Arabian authorities will take steps to prevent any further deterioration in the government’s fiscal position beyond our current expectations.

RATING ACTION

On Feb. 17, 2016, Standard & Poor’s Ratings Services lowered its unsolicited long- and short-term foreign- and local-currency sovereign credit ratings on the Kingdom of Saudi Arabia to ‘A-/A-2’ from ‘A+/A-1’. The outlook is stable.

At the same time, we revised downward our transfer and convertibility (T&C) assessment on Saudi Arabia to ‘A’ from ‘AA-‘.

We now anticipate a current account deficit, equivalent to 14% of Saudi GDP in 2016, compared with 6% of GDP in our October review. 

*  *  *

Other Gulf oil producers got the knife as well as Oman and Bahrain were cut to BBB- and junk, respectively.

• S&P: OMAN CUT TO BBB-FROM BBB+; OUTLOOK TO STABLE FROM NEG
• BAHRAIN CUT TO JUNK BY S&P ON LOWER OIL PRICE ASSUMPTIONS

Here’s the punchline from S&P: “We do not expect the agreement on Feb. 16 between oil ministers from Qatar, Russia, Saudi Arabia, and Venezuela to freeze oil output.”

We don’t either.

Finally, we ask “who knew what yesterday?”

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