Fresh off of Monday’s “a violent short squeeze could be in the cards” call, Nomura’s Charlie McElligott is back and as you can probably imagine, he’s sticking with that in light of Tuesday morning’s rally.
The good mood on Tuesday morning came courtesy of headlines that suggest China is considering slashing tariffs on U.S.-made cars to 15% from 40%. That news that was itself a kind of follow-up to the story about Steve Mnuchin and Lighthizer chatting with Vice Premier Liu He on the phone, an ostensibly positive development considering worries around whether the ongoing Huawei drama might deep-six the trade talks.
“Spooz through yesterday’s highs triggering obvious stop-losses from dynamic hedgers using futures and comically now ~+80 handles from yesterday’s lows”, McElligott wrote on Tuesday morning.
It’s the same story here from where Charlie is sitting. A move through key re-leveraging levels for CTAs could see the rally turbocharged. “As we currently stand, the risk of forcing an Equities cover from Systematic CTAs, which per our QIS model had just turned ‘Max Short’ across majority of global Equities futures, is high, with SPX likely to see a forced cover and going from ‘-100% short’ to ‘+26.1% long’ at ~ 2666.20 in SPX”, he says.
He also reiterates something we detailed extensively here on Monday evening (see second linked post above). Namely that last Friday’s bloodbath might have led the fundamental/discretionary crowd to unload longs, putting them back in a position where they have to chase the rally on gap moves higher. And then there’s dealer positioning. All in all, Charlie thinks you’ve got both a “real” and a “de facto” gamma effect going on.
“The macro catalysts I presented yesterday for US Equities upside remain, while the tactical positioning dynamics are now even more acute”, he writes, on the way to underscoring the idea that “fundamental funds have been in ‘net-down’ mode by selling longs and ‘grossing-up’ shorts in single name / ETF and index futures in turn, creating the kindling for a massive short-squeeze over the next month via both this implicit- and explicit negative gamma.”
This is all conspiring with year-end as hedge funds face the uncomfortable prospect of sitting on underperformance and wondering what to do given the possibility for a squeeze higher (which, if they don’t participate will just add to underperformance, but if they do try to get on board and it goes wrong, will leave them even more jaded than they probably were last week after getting burned on any exposure that was rebuilt late in November).
“The largest near-term catalyst for a crushing Equities move higher remains fund positioning, which is creating an enhanced-risk of positioning squeeze, as it builds fodder for a violent bear-market rally which nobody owns”, McElligott concludes, before driving the point home one more time by emphasizing that this is “ESPECIALLY [true] into the final weeks of a horrible 2018 performance backdrop with zero appetite for further drawdowns—thus, negligible net length.”
The title of Charlie’s Tuesday morning blast:
SQUEEZE GOING TO ’11’ ON FRESH CHINA HEADLINES, MACRO CATALYSTS AND OFFSIDES POSITIONING