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‘Even Messier’: Nomura’s McElligott Conducts Post-Mortem After Bloody Monday On Wall Street

"A sloppy situation within the U.S. Equities space is getting even messier".

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.

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Goldman’s rough day:

GS

GE spreads ballooning (2035s shown below):

GESpreads

(Bloomberg)

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.

CM1

(Nomura, Bloomberg)

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.”

CM2

(Nomura, Bloomberg)

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).

LSHF

(JPMorgan)

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.

CM3

(Nomura, Bloomberg)

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.


 

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5 comments on “‘Even Messier’: Nomura’s McElligott Conducts Post-Mortem After Bloody Monday On Wall Street

  1. No one should be surprised by what is happening. Over 30B rolls off the Fed balance sheet on 11/15. and the Treasury continues to need record amounts of new money on top of this volume, Layer on a tapering by the ECB and most likely a continued roll-back from the BOJ and you get a bloodbath in equities on Wall Street. The market leadership collapse in tech is courtesy of the BOJ and the PBoC, who by the way have every intention of making sure that Trump will not win the trade war without a financial bloodbath, one which they figure he will not be able to survive. Meanwhile Xi has a life long term.

    The Apple falling from the tree is a clear signal. As the Chinese say, “we would rather own the Apple orchard that eat all the apples.” Currently Apple Inc. is a servant to communist China.

    All that is happening is very predictable, and it does not take someone analyzing short gamma or long / short vol volume to figure out what is happening..

  2. Why would anyone be buying “value” stocks in a slowing global economy, slowing US economy, tightening financial conditions environment, and the risk the Fed goes to far? Seems crazy to me. Sure some of these growth names have risk to numbers in a recession but at hopefully lower prices/better valuations soon (and much better than when many were buying them 3 months ago) I will be betting they outperform the “value” names.

    • Spunky McGregor

      I think the most direct answer to your question is that people invested in growth equities have the most to loose in a downward-trending environment. Those stocks valuations are already in pretty rarefied air. They’ll come down, and the losers will be buried in history. Value stocks will probably fall in concert, but I think conventional wisdom is that they will fall less.

  3. Spunky, i am not sure. Typically value performs at the end of the cycle as commodity names, industrials see econ growth benefits and higher inflation. The they transition to defensives as the realization of a recession starts to appear. Agreed valuations are high on growth stocks but the numbers have potentially less risk on a slowdown (generalizing) and with lower discount rates future defensible CFs are worth more. “Value” stocks are more capital intensive and have poorer bal sheets vs growth names and secular trends still favor growth names (as true growth is rare and will get rarer still).

    Yes, they were over owned and suffering from HF problems but a lot of these names will outperform from here IF we have seen peak GDP growth.

    Maybe i am wrong and growth picks up but the premise of the piece is slowing growth, tighter financial conditions and Fed making a mistake. That is a bad situation for “value” stocks. Value viewed as low P/B, low P/E etc. These growth names have ok to good FCF yields, strong bal sheets, and better stability/growth in future cash flows (defensible biz models with moats). If rates go to 6% they’ll go lower but rates probably dont stay there long.

    I still can’t see the thinking of owning value stocks based on the premise if slowing growth, tighter fin conditions and Fed going too far. Though growth still feels mostly pricey on an absolute basis. But i am looking to add growth names on pullbacks where the valuations look good.

    Thanks for the help Spunky, let me know what you think.

  4. I should add i view value as a discount to intrinsic value rather that trailing P/E, P/B etc though the industry uses the later definition.

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