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Don’t Blame The Quants For Wednesday’s Tech Rout

"Yesterday did not feel 'quant-y' to me."

On Wednesday afternoon, in “Here’s Why You Don’t Want Tech To Succumb To Regulatory Jitters“, we talked (again) about why it’s critical that big-cap tech doesn’t roll over. The context was of course the selloff in tech shares that accompanied Sheryl Sandberg and Jack Dorsey’s testimony on Capitol Hill. Specifically, the Nasdaq 100 had one of its worst days relative to the S&P of 2018. Wednesday was easily the biggest underperformance in that regard since the late-July FANG+ correction.

Underperformance

“That’s likely bad news for the recently resurgent Growth/Momentum strategy that had reasserted itself midway through last month after an egregious stretch of underperformance”, we wrote, implicitly referencing recent notes from Nomura’s  Charlie McElligott, who midway through last month called for a rally in the consensus U.S. equities fund strategy that took a severe beating in the six weeks or so through August 20.

WhatHappens

(Bloomberg, Nomura)

As noted in the text overlay there, Growth/Momentum rolled over versus Value and at the same time, the most shorted names squeezed higher, leading directly to the kind of underperformance you see in the following visual:

HedgiesVsSPX

(Bloomberg) 

Ok, so McElligott suggested that the underperformance of Growth/Momentum versus Value was likely overdone, thus his tactical call for a reversal of the reversal (if you will) and the accompanying suggestion that recent underperformance versus benchmarks and decreased net leverage on the part of the buy-side could help catalyze new highs on U.S. equities as active investors played catch up by “grabbing” for exposure (all contingent on a pullback in the dollar).

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September Of The Flying Pigs

Again, McElligott detailed that call in his daily notes from August 14 through August 21 and it turned out to be prescient. So prescient in fact, that he took profits two days ago.

“Due to the massive +++ PNL move in ‘1Y Momentum,’ I am now getting much more tactical”, he wrote on Tuesday, adding that “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.”

And not a moment too soon, as it turns out, given what happened on Wednesday.

Given all of that, Charlie’s Thursday note is worth a read. Here’s Charlie explaining that he took profits at just the right time:

The U.S. Equities space yesterday was not an “index level” story—with SPX closing down a modest -28bps, and with eight of eleven sectors “up” on the day; Instead, it was a story of another drawdown and powerful thematic- and factor- reversals after what had been a solid week of performance stabilization—proving that my actions to take profits on my “Momentum Longs” over the past few sessions into strength was the “right” trade.

The very-profitable “long Momentum factor” call, which was ”legged-into” since early August ahead of the September seasonality (and as mentioned, now largely monetized with 2/3 of the notional position now reduced after the positive returns came “fast and furious” +10.9% from Aug 1st through Tuesday’s close) experienced a much more violent “unwind” yesterday, with “Momentum” factor L/S strategies around the Street down -2% to -3% on the day.

CM1

He goes on to add a bit more detail around the points made above about hedge funds being forced to increase exposure and “chase” the benchmarks after underperforming.

“A huge part of my call to get long ‘Momentum’ factor into the September ‘window dressing’ seasonality was the fact that Equities fund underperformance had been so pervasive over the past two months—meaning that perversely, there was now ‘fodder’ for a spectacular ‘chase’ into Market (Beta) Exposure—likely being seen via a ‘grab’ into ‘the stuff that had been working’ on both the long- and short- side—thus, ‘Momentum’ factor L/S’,” Charlie writes, adding that indeed, “L/S funds took up their Beta to the S&P to the 100th %ile last week, with the 20d rolling Beta of HFR Equities Hedge Fund Index to the SPX at 74%–an all-time high (was just 30% at start of month)”.

CM2

(Bloomberg, Nomura)

Ok, so if you’re reading all of that correctly, it’s pretty easy to see where Charlie is going with it in terms of whether Wednesday represented a dreaded “factor rotation” out of Growth/Momentum (that’s something that’s come up over and over again over the past couple of years). His contention is that what you saw were active managers monetizing their gains from the past couple of weeks.

“Yesterday did NOT feel ‘quant-y’ to me on the ‘unwind’ of this tactical ‘money-maker’—because it was the discretionary / active community by-and-large who was inquiring on making this ‘market grab’ over the past few weeks, and thus flexible to ‘take it off’ at a profit”, he writes, adding that the incentive to take some off the table was likely exacerbated by “the dual market-negative ‘pin-pricks’ of the 1) D.C. hearings on Social Media & Tech / potential for regulation and 2) EM tizzy which set the table for a ‘weak’ risk-footing…and ESPECIALLY ahead of the ‘tale of two halves’ September ‘risk seasonality’.”

As for whether there’s any data to back that assessment up, the answer is “yes” or, at least the answer is “yes, McElligott has a chart.” Here it is: 

CM3

(Bloomberg, Nomura)

Of course all of that raises the following question: What happens if tech continues to come under pressure from jitters about regulation?

It is entirely possible that the regulatory overhang persists into the U.S midterms as the issue of election meddling continues to make the nightly news. Eventually, you could see a “quant-y” rotation out of the space (to quote McElligott) and assuming there are still some folks hanging around in there who “grabbed” for exposure to catch up with benchmarks late last month, more discretionary selling could exacerbate the situation.

Anyway, who knows. All you can say now is congrats to anyone who rode this wave to some solid gains over the past couple of weeks before it finally crumbled on Wednesday.

CM5

(Bloomberg, Nomura)

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