It’s “death by paper cuts” for U.S. equities, according to a Monday post-mortem penned by Nomura’s Charlie McElligott on a day when the Nasdaq took a severe beating thanks in no small part to iPhone demand jitters, which served to exacerbate concerns that October’s Tech rout is far from over.
“A sloppy situation within the U.S. Equities space is getting even messier, as the (negative) performance-driven de-risk/de-gross of the past month escalates”, McElligott laments, on the way to characterizing Monday’s rout as a kind a “pile on” dynamic wherein possible front-running of the hedge fund redemption D-Day collided head on with i) the Lumentum news, ii) GE’s ongoing (and extremely diligent) efforts to get to zero and iii) the worst day for Goldman since 2011, as the 1MDB demons are finally coming home.
Goldman’s rough day:
GE spreads ballooning (2035s shown below):
Beyond the idiosyncratic stories, Monday felt a lot like some of the worst days from October, at least as far as Growth getting maimed. The Apple story was just about the last thing anybody needed in an environment where folks are increasingly concerned about the future for the market’s perennial leaders/consensus Longs.
“The three-year hiding place in the Apple phenomenon [is] breaking down, further contributing to destruction in Growth-heavy long portfolios, as well as large gains in Value market-neutral strategies, where despite actually somewhat lower Value Longs on the day, the Growth companies which make up Value Shorts in the market-neutral factor strategies are being crushed”, McElligott writes.
In the same vein, he goes on to note that the ongoing exposure unwind (“de-Beta’ing”, if you like) has “rationally corresponded with the Equities L/S hedge fund performance swoon, as it captures that many funds were long-er the market than they realized.”
JPMorgan’s Nikolaos Panigirtzoglou spent a ton of time last month reiterating the role Long/Short equity likely played in exacerbating the drawdown. “The monthly HFRI Equity Hedge Index lost more than 4% in October, the worst monthly performance since January 2016”, Panigirtzoglou wrote in a Friday note. You can see the de-risking reflected in the Long/Short crowd’s beta (right pane below).
McElligott also notes that support is breaking in places you don’t really want to see it break – at least not if you think the market isn’t ready to transition to a new regime where the leadership baton can be passed without the relay being dropped.
Meanwhile, don’t forget about systematic flows which are either a bullish or bearish catalyst depending on the day, who you ask and, in this case, what your window is. “We see a mechanical phenomenon, where an important ‘rally date’ falls out of the 1M sample set (by today’s close) from our systematic trend model, which means -$32.8 billion of S&P futures for sale on a close (if we remain below 2763 in SP1), and sending the overall allocation in S&P from ‘100% Max Long’ back down to just ‘65% Long'”, McElligott muses, before flagging a similar situation (i.e., an important date dropping out of the window prompting mechanical deleveraging) for Nasdaq futs and Russell minis.
The overall thrust of Charlie’s Monday post-mortem is that while positioning is ostensibly cleaner after October and while the buyback bid is back in play, that’s likely to be small comfort on days where idiosyncratic (or “left field”) blowups serve to dampen the mood. That, in turn, prompts everyone to focus on the negatives, not the least of which is the fact that playing out in the background of the “year-end squeeze higher” narrative is an ongoing tightening in financial conditions and the accompanying prospect that the Fed will ultimately end up overshooting in the course of trying to stay out ahead of inflation.