Over the last couple of weeks, Nomura’s Charlie McElligott has variously suggested that when it comes to U.S. equities strength in general and a resumption of Growth/Momentum outperformance in particular, markets could see “more cowbell” (so to speak) in September.
After underperforming handily from July thanks in part to Facebook’s plunge, the ensuing correction in FANG+ and a squeeze in the most shorted names, the consensus U.S. equities fund strategy started to “work” again midway through last month around the same time benchmarks summited new peaks on Wall Street. That of course coincided with the dollar taking a break from an ascent that started in April.
In addition to the “consensus” strategy starting to work again, it’s also entirely possible that the buy-side will need to play catch up to the rally because, well, because this doesn’t look great if you’re charging people some derivation of “2 and 20”:
If what’s worked for hedge funds starts working again and managers start trying to increase exposure to play catch up, it could fuel further strength in U.S. stocks contingent, again, on the dollar not resuming its rally with the effect of tightening financial conditions and throwing everyone from New York to London to Hong Kong for a loop.
Generally speaking, all of that is consistent with the notion that from here, U.S. equities strength is going to be at least partially beholden to the dollar. All year long, U.S. stocks have remained resilient to turmoil abroad, leading directly to a historic divergence with the rest of the world. The explanation for that is simple: U.S. fiscal policy was simultaneously dollar positive and U.S. equities positive.
Long story short, markets seem to have reached something of a breaking point with that in early August as folks started to question how much longer U.S. equities could ignore weakness in ex-U.S. assets. What was needed was a bit of dollar weakness to buoy emerging markets in order to avoid a scenario where an outright EM meltdown boomeranged back stateside – or so goes the narrative.
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Fortunately, we got that dollar weakness (thanks to, in chronological order, Trump’s Fed criticism, the PBoC reinstating the counter-cyclical adjustment factor in the yuan fix and an ostensibly dovish speech from Jerome Powell in Jackson Hole), and the relief in EM was accompanied by new highs on U.S. equity gauges.
Starting last week, that relief in EM gave way to renewed concerns about Argentina and Turkey and on Tuesday, the rand is in the firing line after the latest read on GDP showed South Africa falling into the first recession since 2009.
With that as the backdrop, Nomura’s McElligott is back on Tuesday to talk about everything noted above.
“EM starting Tuesday in now-standard ‘messy’ fashion, with South African Rand taking a beating after 2Q GDP data shows the country entering a recession”, he writes, adding that “with broad EM as well as ‘high-beta’ G10 weakness, USD is making one-week highs and contributing to resumption of pressure on Industrial Metals for the fourth consecutive day (Copper -2.6%).”
That’s obviously not great for risk sentiment. “On this ‘higher U.S. Dollar’ point and continuing to confirm recent observations, the Quant-Insight tool is now showing that the short-term (83d) U.S. Equities model is exhibiting the largest ‘negative sensitivity to USD’ in four months.” Again: Further strength in U.S. stocks is contingent on the dollar not rallying strongly from here.
So what about the September Momentum rally and the idea that hedge funds will keep “grabbing” for exposure? Well, here’s Charlie on that:
As it was a key part of the call to get long “Momentum” factor in U.S. Equities (finished August +9.5%), Hedge Fund Long-Short funds have indeed “grabbed” at market exposure: our internal metrics show that L/S funds took up their “Beta to the S&P” to the 100th %ile, in large part thanks to ripping “Momentum Longs” (“Beta to Mo Longs” now 96th %ile, from 44th %ile a week ago).
Asset Managers too “grabbing” at SPX as expected off the multi-month performance drag, adding a monster +$13.9B of S&P futures last week.
Ok, so the natural question here is this: Given how well this tactical call has played out, is it time to take some profits, or should everyone wait around on that “monster” September melt-up McElligott predicted?
The answer, according to McElligott, appears to be “both”, where that means take some off the table, but look for a “tale of two halves” phenomenon when it comes to this month. We’ll leave you with his color on that point…
Due to the massive +++ PNL move in “1Y Momentum,” I am now getting much more tactical. I have now taken-profits on 1/2 of the trade and will continue to reduce exposure as funds clearly “pre-positioned” into Sep seasonality / “window dressing” phenomenon.
I will likely keep on the “Short Momentum Shorts” leg into the back-half of September, as there is historical weakness in “High Beta” / “Volatility” (while “Low Vol” / “Defensives” rally in the final two weeks of the month).
September for U.S. Equities sets-up for a “rally in front half of month, sell off in back half”–funds “forced-into” the melt-up at start of month / +++ historic for the first two weeks, just before post-expiry dealer gamma comes off and the “buyback blackout” picks- up for many of the largest S&P sectors.