10Y banks bonds S&P 500

‘Someone Or Someones Are Really Scared’

"... we’ve been doing this long enough to know when acute demands for liquidity will likely arise and that’s what it feels like."

Listen folks, Wells Fargo’s Chris Harvey is “not prone to fear mongering”, ok?

And he says as much explicitly (as in, those quotation marks denote an actual quote) in his latest note.

That said, he’s “been doing this long enough to know when acute demands for liquidity will likely arise and that’s what it feels like” right about now.


When last we checked in on Chris, he was predicting more near-term weakness for momentum in the face of calendar effects and systematic selling and in a note dated Wednesday, he has a series of warnings for investors tied to, among other factors (and “factors” can be taken figuratively and literally there) what he’s characterizing as a “recoupling” of Chinese equities with U.S. stocks.

To be clear, Chris needn’t include the caveat about “fear mongering”. Nobody who reads his notes would think he’s “prone” to trying to scare people and the idea that Chinese stocks are starting to “exert gravity upon US equities” is more of a “it’s about time” thing than it is some kind of dour assessment of the prevailing landscape.

The entire world has to a certain extent decoupled from the U.S. and especially from small caps. This is what “America first” looks like:


Wednesday’s price action in U.S. equities certainly seemed to suggest that it’s going to take more than a marginally less confrontational approach to investment restrictions to  shore up confidence. Here’s what I wrote last night:

What I would encourage you to be aware of is that the administration’s attempt to bail out markets on Wednesday by taking a less aggressive approach to restricting Chinese investment in U.S. industries was faded aggressively. Here’s an annotated chart of S&P futures:


To me, that signals that the bar has been raised in terms of what counts as “conciliatory” on trade negotiations.

Harvey echoes those sentiments.

“Rather quickly, price action in the US equity market has become fluid with the proverbial Chinese-American rubber band stretched too far,” he writes, adding that “Thursday’s action felt like the start of an unwind, and unluckily we have a reasonable amount of data to support our fears.”

What’s that data, you ask? Well, for one thing, Chris notes a “strong rally in Treasurys despite the economic and inflationary improvement.” Here’s 10Y yields:


“In our view this is providing a significant risk off signal and the fixed income risk-off message is spilling into the equity market,” Harvey continues.

I don’t want to get too far down the rabbit hole here, but it’s worth noting that this kind of signaling is especially dangerous give modern market structure.

If you’ve got a minute, let me take you on a brief trip back to June 7. Here are some excerpts from something I wrote about the BRL panic that unfolded that day and the accompanying “flash rally” in Treasurys:

… look at what happened in U.S. Treasurys when the bottom was falling out for the BRL on Thursday afternoon:


That is not a coincidence. Here’s another way to visualize it:


That move in the real towards 4.00 triggered an acute flight to safety that looks like it stopped someone out on Thursday. Here’s Bloomberg’s Cameron Crise, live-blogging it from Thursday afternoon:

Judging by the way my IB chats lit up, that downdraft in Treasury yields generated a lot of excitement. It certainly looks like there was a big stop-out; 10 minute volume in TY futures exceeded that of both month-end and payrolls, with 185k contracts trading during the spike higher in price. There were similar volume spikes in FV and US as well.

U.S. stocks held up pretty well during this episode but you get the point. These EM moves can spill over that quickly and what you see in those two charts is indicative of liquidity disappearing. It’s worth mentioning that there was a 10-year Treasury options block trade in there as well.

When you’ve got stretched positioning in the Treasury complex (i.e., massive shorts), a quick spike lower in yields like that which accompanied the BRL’s plunge towards 4.00 on Thursday afternoon has the potential to trigger short covering, which obviously adds fuel to the rally in bonds.

Well, when algos see that kind of rally, they can’t discern what’s going on, which means they’ll either chase it or else just get out of Dodge, with the latter representing a dearth of liquidity. What kind of signal do you think plunging Treasury yields send to the rest of the market? Hint: it sends a risk-off signal. All of that underscores the fragility of the modern market structure.

Clearly we haven’t seen anything like that this week in terms of an acute spike lower in yields, but that gets at the heart of the issue when it comes to how the signal effect from Treasurys has the potential to be amplified by rickety market structure.

Ok, so getting back to the other signs Wells Fargo’s Harvey sees, he also reiterates what he said earlier this week about an “an unwinding of Tech/Momentum” and he flags the rally in the dollar which he says is suggestive of a flight to quality. Here are his takeaways:

  • Someone or someones are really scared
  • Someone or something is unwinding a very large macro trade/book
  • Pension funds and asset allocaters are aggressively rebalancing
  • Investors are rushing to cut Momentum exposure
  • Or all of the above

He then goes back to his Momentum call from earlier this week on the way to noting the following:

We do know of a $2 billion Market Neutral Fund that’s down almost double-digits YTD. In our experience, AUM and PMs do not stand still with that type of shortfall and in that type of absolute return product. The fund has been overweight Tech/Consumer Discretionary/ Financials/Industrials and underweight Telcos/REITs/Energy—a toxic combination as of late. More importantly, there are plenty more funds positioned as such.

He goes on to lay out a bullet point list of what he calls “things that are making us go Hmmmmm?”

  • In the last 2 weeks of 1Q18, the Momentum ETF (MTUM) sold-off 5%.
  • From June 15, 2018, the Momentum ETF (MTUM) has sold-off 5%
  • The last 2 weeks of 1Q18 were a difficult time for Active Managers (Active Management, Apr’18).
  • The last 5 days have been a difficult time for Active Managers (It’s A Footrace to Quarter-end, Jun’18).

We’ll just rehash/update this visual from Tuesday:


Finally, Harvey flags the recent malaise in the financials, suggesting that the woes for European banks…


… are “becoming a financial yoke around the neck of US Banks”. Of course passive selling isn’t helping (sorry ETF defenders). The XLF is down 13 sessions in a row:


Outflows there are picking up:


And this is ugly:


The curve at cycle lows doesn’t help.

Oh, and finally, Chris reminds you not to fight the Fed:


Any questions?

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