Over the weekend, we brought you some thoughts on the ongoing “chop” in U.S. equities, where “chop” means the inability to hold trade-headline-related rallies and the supposed “floor” provided by the simple fact that some investors simply don’t have much cash exposure left to de-risk.
At this point, though, “chop” is something of a euphemism. This “chop” has a clear trajectory and that trajectory is “lower”.
What you see in that chart is the product of a number of factors, all highlighted here over the weekend and discussed in a Friday note by Nomura’s Charlie McElligott who, on the heels of his immediately infamous “CTAs de-risking now live” call from December 4, called for a possible squeeze higher. That prospective squeeze fell victim to the overarching “sell the rip mentality” and myriad other factors as discussed here on Saturday.
Fast forward to Tuesday and McElligott is out with a sweeping assessment called “Fed at risk of disappointing very dovish expectations and why we’re puking.” The short version, is this, from Charlie:
Forced VaR-down, retail outflows and institutional pile-ons, early Oct / Nov fund redemptions building into tax-loss selling into YE, pension fund de-risking into a hiking-cycle (buying USTs / STRIPS vs selling Equities as they achieve funding ratios), systematic trend funds again turning ‘short,’ very negative (~1st %ile) SPX index option greeks for both negative Delta- and Gamma-, resumption of the buyback blackout window (already started for banks, transports and household goods), slowing global growth against shrinking G3 central bank balance sheets and net / net “tighter” financial conditions…and all into a Fed this week which due to enormous “dovish” expectations built-in has a risk of disappointing the markets with a more “hawkish” tone that has to remain somewhat “neutral” despite the “balance-of-risks” shifting to the downside.
But you want the longer version, don’t you? Of course you do, and McElligott is more than happy to “get right to it” (that’s a direct quote from Tuesday’s missive).
First of all (and as blasted out from the rooftops by anyone with access to the data and a megaphone last week), retail investors are getting out of dodge. McElligott provides the detailed breakdown, complete with percentile ranks and some perspective on seasonality. To wit:
Last week’s tectonic US Equities fund outflows: -$27.7bil (sub 1st %tile since 2000, 6th %tile as a % of AUM), with Institutional finally reducing in earnest -$11.9bil this week (however still +$76.3bil of buying for the year—so more potential supply to go) with Retail now really stepping it up -$15.5 bil this week (sub 1st %tile) and now 6m outflows hitting -$59bil (8th %tile) and over the year -$102.4bil…and this is coming with Nov and Dec as historically the 1st and 2nd best months for monthly US equities flows on avg since 2005 = Total puke, this is the “anti-seasonal” which nobody expected.
He goes on to note that asset manager flows have now “turned capitulatory”, and by that he means that in the week through last Tuesday, “an additional -$16.3B sold in US Equities futures.” Breaking it down, that’s “-$15.2B SPX, -$1.1B in Russell” and a reduction of that crowd’s aggregate net long to +$47.3B vs a long-term average of +$59.2B.
As Charlie (and plenty of others) have been keen to note, the timing on all of this was horrible for active management. “This performance wobble came at the perfectly wrong-time for funds, where already fragile conditions due to end-of-cycle perception and a volatile geopolitical climate also occurred with the tough part of the calendar into significant fund redemption flows in Oct / Nov (ahead of the Q4 redemption request window in mid-Nov) and much larger tax-loss selling across the various fiscal year-ends of Oct / Nov / Dec,” he writes, before flagging yesterday’s TIC data which betrayed a sixth straight month of selling from official and and private foreign investors.
Next, McElligott revisits a subject he broached in his Friday note – namely, pension fund rotations. Apparently, Charlie went looking for some confirmatory evidence and found it courtesy of a colleague in the FI strategy department. Here’s the chart (and God knows I’m tired of the Smart Money index charts, but here it’s appropriate):
So what about CTAs? How are they “feeling”? Well, according to Charlie, they’re feeling “Max Short” and are now a long – long – way from covering.
On options, McElligott rolls out the old “Greeks gone wild” characterization, noting that “SPX / SPY consolidated greeks keep getting more negative with spot, even with calls over puts.”
You want numbers? Fine. Charlie’s got numbers to spare. Here you go:
- Net overall Delta is -$506.8B (a 0.4%ile level back to 2013) and front-month -$325.3B / front-week -$228.6B with modest notional bias to upside
- Net Gamma -$18B per 1% move + or – (a 1.6%ile level back to 2013), net gamma -$46.5B on a 2% move—with the size strikes that matter the most being 2600 ($5.9B gamma), 2650 ($4.1B), 2500 ($3.8B) and 2550 ($3.7B) and also a bias to the upside
Does this presage potentially wild gyrations? Maybe!
“Point being that we are likely to see incredibly-erratic price-action into Friday’s Quad Witch expiration and horrible year-end liquidity / dealers offering little balance sheet”, Charlie warns.
Finally, McElligott notes that we’re entering the blackout window and three quarters of the S&P will be “out of the market” (i.e., reduced corporate bid) by the 26th.
So, if you’re looking for a point-by-point explainer on why exactly it is that no rally (maybe including the one we’re already seeing on Tuesday morning) can hold, you are now armed with just such a guide.
Whether the Fed can turn the tables on all of this is questionable at best. And in that regard, Donald Trump wishes Powell the best of “luck”…
I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also, don’t let the market become any more illiquid than it already is. Stop with the 50 B’s. Feel the market, don’t just go by meaningless numbers. Good luck!
— Donald J. Trump (@realDonaldTrump) December 18, 2018