If you step back and think about the market turmoil that’s unfolded in 2018 it can be clearly divided between the technical selloff that unfolded in early February and the more “fundamentals”-based weakness that’s accompanied regulatory concerns around tech and generalized jitters about trade wars.
The February rout did have a fundamentals-ish trigger – the above-consensus AHE print that accompanied the January jobs report seemed to “validate” (scare quotes there for a reason) inflation concerns at a time when aggressively expansionary fiscal policy is being piled atop an economy operating at full employment. That raised questions about whether and to what extent the Fed and Jerome Powell would be inclined to act preemptively to cool things off, and in the week leading up to Vol-pocalypse, risk parity and balanced portfolios had a rough go of it as stocks and bonds fell in tandem. That said, the real pain came courtesy of the VIX ETP rebalance risk being realized on February 5. The historic VIX spike precipitated by that black swan event led directly to a cascade of de-risking by the systematic crowd and in that sense, it was a technical plunge and could plausibly be attributed to one-off factors.
Since then, equity weakness has been down to non-technical factors, most notably the trade tensions and regulatory risk surrounding tech. The tech issue is particularly vexing as it suggests the names which have variously served to supercharge and sustain the broader rally may be subject to the type of regulatory risk that could imperil their business models. The late March tech bloodbath cast considerable doubt on the notion that somehow, tech had become a “safe haven” in an increasingly volatile investment environment.
“QQQ outperformed its normal relationship with macro assets by about 6% from Jan 1st to Mar 12th,” Goldman writes, in a piece out earlier this week, before noting that “there was a flight to the safety of Tech following February volatility leading the sector to get crowded.”
Since March 12th, however, Goldman points out that “QQQ has declined about 4% relative to macro assets.”
There are two ways to look at that. One thing you might plausibly say is that any crowding seen following the February market turmoil hasn’t been completely unwound. Indeed, Goldman says “the tech mean reversion” is only “2/3rds complete.”
On the other hand, the bank says that recent underperformance in the space may have more to do with that normalization (read: overcrowding unwinds) than it does with investors actually fearing regulatory bogeymen. If that’s the case, it could be that the increase in the put-call skew in the space is an opportunity to gain “cheap” upside exposure to tech ahead of earnings.
While headlines about tech stocks have dominated the news cycle and have been widely cited as a key cause of stock price weakness by the investors we speak with, we believe it is more likely that simple crowding earlier in the year was a key reason for the recent underperformance. We think this observation should be reassuring to fundamental managers that have yet to see a strong connection between regulatory risk and near-term fundamentals (i.e. maybe there isn’t a big tail risk developing here?). While we continue to see some overpositioning in Tech, we see less of a headwind after he recent mean-reversion. Given the sharp increase in put-call skew in the tech sector, we believe calls are unusually attractive in the tech sector ahead of earnings.
So you can take that for what it’s worth, but clearly the risk is that earnings disappoint and the negative headlines re: regulatory risk continue unabated. Then you’re just burning premium.