The headline hockey has now become a complete and utter farce.
One minute, the trade deal is crashing and burning thanks to the U.S. compelling the Canadians to kidnap Chinese nationals at airports and the next minute Chinese policy advisers are hard at work overhauling Xi’s “Made in China 2025” initiative so it’s more inline with Trump’s vision for the future of tech.
Or, flipping the situation around, one minute China is all set to slash tariffs on U.S.-built cars and the next minute the Trump administration is set to unveil a multi-agency smear campaign aimed at calling out China for espionage.
Meanwhile, domestic politics is a complete mess. Trump is threatening to close the government in lieu of $5 billion in wall funding and the President’s former lawyer is getting sentenced to three years in prison for crimes he says he committed at the behest of the very same President.
Reconciling all of this is obviously impossible, but on Wednesday, virtually all of the headlines have been risk-on catalysts and Nomura’s Charlie McElligott (who this week has been pushing a tactical squeeze higher call for equities) notes that today’s rally comes as a real
kick in the balls gut punch for fund managers who are caught in the chop and paralyzed into year-end.
“The latest move higher in equities comes to the chagrin of investors who have purged net exposures / leverage and are watching this latest ~+3.4% S&P futures rally off the Monday lows from the sidelines, due to the horrible run of performance and proximity to year-end effectively shutting down most funds with zero willingness to hold risk in light of the headline violence and into increasingly deteriorating year-end liquidity with balance sheet constraints”, he writes. Here’s a visual of the rally off the Monday lows:
If you’re wondering what Charlie thinks about the one-sided screaming match that unfolded on live television yesterday, you’re in luck. “Shaking off the surreal gong show ‘live-look’ into US budget talks between POTUS and Dem leaders midday yesterday which made the risk of a government shutdown very real for anybody watching and derailed what was building into a powerful risk rally, the slowly building ‘signs of movement’ on China / US trade have again picked-up and buoying risk assets,” he notes, before citing all of the myriad ostensibly upbeat trade headlines that have crossed over the past 24 hours.
On Italy, McElligott is as skeptical as we are, although acknowledging that for the time being, the new budget proposal trial balloon is bullish. “We saw an additional macro relief catalyst, as a report stated that Italy is ‘said to’ propose a 2% deficit target to EU in another theoretical ‘bending of the knee’ to political and market realities in recent weeks”, he writes, on the way to noting that the number of people who have bowed to the market recently is growing, with Conte (if not Salvini) joining Powell, Trump and Xi.
The read-through from the Italy situation (to the extent it buoys the euro) is good for Charlie’s tactical risk-on call. If you think “way” back to yesterday, you might recall that part of the thesis here is that the Fed’s dovish pivot could end up leading to a softer dollar and if crowded logs in the greenback are squeezed, any dollar downside will be magnified to the benefit of commodities and inflation expectations. Any euro strength on the Italy “deal” would contribute.
“This Italian ‘breakthrough’ / stand-down could (if it were to get legs beyond this ‘trial balloon’) be very important to broad risk-assets because it could help drive a powerful rally / squeeze in ‘max short’ Euro, which in-turn can send (crowded long) US Dollar weaker on positioning alone”, he says. The single currency has obviously caught a bid today on the Italy headlines, etc.
As to positioning, Charlie of course delivers the customary update. “From a systematic CTA trend perspective, as we did NOT close above the 1Y bucket ‘trigger’ level yesterday despite the intra-morning ‘breach’, the CTA flip-zone from current ‘-100% Max Short’ to ‘+26% Long’ remains very much in-play, requiring a close above 2666 to generate large notional buying, with a move above 2722 to get to ‘+67% Long’ and triggering ‘+100% Max Long’ re-leveraging over 2755 all outstanding (spot being 2661)”, he says. So if you’re looking for the granular details on his recently famous/infamous CTA model, there you go.
Regarding active managers, the situation is, well, it’s complicated as we’ve spent more time than we ideally would like documenting over the past week. That crowd is basically stuck in the chop with no good options. “From the active side, SPX index option skew had flattened in recent days via Calls richening at the chance of catching a rally into year-end, as clients increasingly monetized their Puts as hedges, especially because they’ve taken down so much of their underlying portfolio length since October”, McElligott muses, before delivering the bottom line as follows:
Yet the inability to hold rallies (Calls again being sold / tapped) with the year-end timing and the performance realities continues to dis-incentivize pursuit of higher US Equities over the next 3 weeks and in fact, against ongoing signs of S&P futures deleveraging into rallies notable “asset allocation” trade flows out of SPX into TY ~ 9:45am EST during a number of days this past week I expect more up / down “chop” through the end of 2018…but with a lot of “puckering” and concern on a breakout.
As usual, there’s more, and maybe I’ll incorporate some additional tidbits into (yet another) hedge fund quandary post later – who knows what I’ll do.
For now, I’ll just leave you with a reproduction (for the purposes of giving you a hi-rez version) of a chart Charlie uses to illustrate the notion that the term premium collapsing to “new ‘Fed normalization’ cycle lows” should men a “relaxation” in cross-asset vol.