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‘Here’s The Deal’: Why One Derivatives Strategist Plans To Be ‘Out’ Of His S&P Long By November 30

"Disappointment risk."

“Here’s the deal: tighter financial conditions, dollar shortage thesis, max QT and trade tariffs are all biting at the same time”, Nomura’s Charlie McElligott writes on Tuesday, laying it out for folks in the simplest possible terms, on the way to saying that he plans on abandoning his tactical S&P “‘outright long'”, which he’s been pushing “due to the resumption of mechanical demand sources in the market over the past two weeks.”

That would appear to be it (for now anyway) on Charlie’s call for a bounce catalyzed by systematic re-risking, macro funds getting long and hedge funds being forced to grab for exposure all against a backdrop where the buyback bid is back in play.

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On the heels of Monday’s bloodbath, McElligott notes that “the key to risk asset stabilization remains movement at the G20, where a best-case detente scenario would be a delay on the third tranche of tariffs planned to launch at the start of the new year.”

As a reminder, reports indicate that if there’s no such “movement” at the G20 (which starts on November 30), the Trump administration is prepared to publish a list in conjunction with duties on the remainder of Chinese imports in early December.

Questions continue to swirl around the outlook for the Trump/Xi meeting. Rumors that the U.S. President had instructed aides to draft a truce earlier this month following a phone call between the two leaders catalyzed a fleeting bout of euphoria, but that was quickly faded. The yuan, for instance, has erased pretty much the entirety of the two-day “black swan” rally that unfolded in the wake of the positive trade news on November 1/2.

On Tuesday, a report that Steve Mnuchin and Chinese Vice Premier Liu He spoke over the phone late last week is providing an excuse for optimism, but you’re reminded that we’ve been down this road before. In fact, talks between Mnuchin and Liu have become something of a standing joke because every time the two make progress, Trump goes out of his way to undermine things. That’s in keeping with precedent set back in May, when the President abruptly reneged on a truce struck between his Treasury Secretary and the Chinese Vice Premier in Washington. That truce (which revolved around the prospect of China purchasing more goods from the U.S.) lasted all of about 10 days.

On Tuesday, Chinese Premier Li Keqiang reiterated that Beijing is “willing to negotiate with the U.S.” in the interest of “find[ing] a solution that is acceptable to both sides.”

For his part, Larry Kudlow told CNBC that talks have indeed resumed with China. “That’s a good thing”, he added, in case you’re Peter Navarro and need a reminder.

But the above-mentioned McElligott isn’t particularly optimistic, although he does note that convincing signs of progress at the G20 would be just what the doctor ordered to turn things around for what’s turning into a “global risk sentiment bleed.”

“This theoretical tariff delay scenario at the G20 is the obvious potential catalyst for upside SPX trades; however, vol. remains expensive and call skew unattractive”, Charlie says, adding that “this equities upside play is further challenged too as investors have pivoted bearishly in light of the negative performance-driven de-gross, and NOBODY wants to sell puts to buy calls.”

He also flags the across-the-board miss for China’s credit growth data out overnight. To call the numbers “uninspiring” would be to understate the case, but as ever, deciphering what exactly is going on under the hood is well nigh impossible. Here’s Goldman’s attempt at summarizing the outlook (this is from a longer note out Tuesday morning):

Monetary authorities were likely not very aggressive with administrative loosening measures in October, possibly because the amount of broad TSF in 3Q was reasonably large. The alternative explanation could be that they don’t have perfect control on a monthly basis and missed the target in September. Endogenous growth momentum remains weak as financial institutions and real economy companies remain cautious, so more aggressive loosening measures are required if TSF is to show a rebound. In recent weeks the authorities clearly started to give more support to private companies. This targeted loosening is likely to lead to stronger TSF growth in November and December.

Whatever the case, just about the last thing the world needs at a time when financial conditions continue to tighten is for the engine of global credit creation to stall out in earnest. On that score, the October new yuan loans and TSF figures are disconcerting, even against expectations for a sharp slowdown.

When you think about that, put it in the context of the massive liquidity squeeze being exerted by the following factors (from McElligott):

  • U.S. Dollar (BBDXY) is at 18 month highs
  • U.S. real yields (5Y TIPS) at 9 year highs
  • “Max Quantitative Tightening,” with G3 Central Bank balance-sheets seeing their YoY rate-of-change contracting to outright NEGATIVE in 4Q18
  • Fading U.S. economic momentum, with the diminishing returns of the tax-cut fiscal stimulus seeing QoQ expectations for US GDP growth consecutively lower from 4Q18 through 4Q19
  • Similarly weaker global GDP growth change expectations, with Japan, Europe and China all weaker in 2018 and EU / China expected lower again in 2019, with Japan expected just ‘flat’
  • Clear reversal and breakdown LOWER in global manufacturing PMIs, with the JPM’s aggregated Global Manu PMI index now down 9 of the last 10 months

GrowthDown

Again, this all harkens back to the same thing, which is that irrespective of the myriad catalysts one might fairly trot out to justify a tactical bullish call into year end, the overarching narrative is one of slowing global growth and tightening financial conditions. The former is showing up all over the place and the latter is readily observable in pretty much any proxy you care to point to.

Conditions

(Nomura, Bloomberg)

Bottom line: Pray for the G20 stick save and in that regard, just know you’re in “good” hands…

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