First thing Wednesday morning, we ran through the variety of factors that have contributed to the “V-shaped” recovery in risk that’s off and running in earnest in 2019 despite last Thursday’s ISM “oops” moment.
Specifically, we touched on everything from the various easing levers being pulled in China to the rebound in crude (and thus risk-positive pause to what was a relentless bleeding of breakevens) to blockbuster performance in trade-sensitive groups on the Stoxx 600 to the impact of the dollar’s ongoing plunge on EM FX to the mammoth rally in high yield.
All of this is set against incessant hints/leaks/trial balloons around the ongoing trade negotiations and you’d be forgiven for wanting to fade every last bit of the recent euphoria – especially in light of the rather underwhelming statement out Wednesday morning from the USTR.
If you are so inclined (i.e., inclined to fade it), note that Nomura’s Charlie McElligott thinks it might have a bit further to run yet before it ultimately collides with “end-of-cycle ‘tighter financial conditions’ realities” and “the still-maintained QT-pace”. That is of course assuming the Fed doesn’t ultimately relent and take concrete steps towards tweaking the balance sheet runoff plan which, in my mind anyway, would change the game entirely.
For the time being, McElligott notes that you may want to stick with a tactical long and as is customary, he’s even more colorful in the way he expresses it than I am, which is saying something because I fancy myself a colorful guy.
“Risk is again ‘foaming at the mouth’ in grabby-fashion”, Charlie writes, conjuring images of crazed investors clamoring for upside exposure as everything moves higher in unison on the back of a suddenly communications-adept Powell.
All of this is broadly consistent with the catalysts McElligott talked about late last month, and you’re reminded that he penned a lengthy missive on December 18 which helped explain “why we were puking” and thus why early-December calls for a tactical rally didn’t ultimately pan out. To those catalysts he adds all of the things we talked about on Wednesday morning. Here’s how he puts it:
The same catalysts I’ve highlighted for a TACTICAL RALLY IN U.S. EQUITIES since late-December continue to positively develop, with a few new additions—1) dovish Fed inflection / evolution continuing to develop (into HEAVY Fed speaking calendar this week), 2) more aggressive Chinese / PBoC easing- & stimulus- actions, 3) bullish US / China trade negotiations “leakage” 4) widespread under-positioning in Equities which will be “forced-in” after missing this Beta-led rally (S&P futures +11.5% / Russell futures +14.5% off late Dec lows) with potential additional “upside kickers” from the Systematic Trend- and Vol- communities; and finally, as laid-out yesterday, 5) the bullish Equities / bearish Rates catalyst of again climbing inflation expectations—largely via Crude’s reacceleration +20% (!!!) since Christmas Eve lows
Allow us to just bask in the hilarity of those moves – they are truly remarkable and it never gets old even after you’ve seen the chart a dozen times.
Ok, so with all of that out of the way (and after expounding at length on the Fed’s “dovish evolution” which, incidentally, “went to 11” on Wednesday with multiple speakers and then the December minutes suggesting that this “evolution” was actually going on last month, Powell’s tone-deaf presser notwithstanding) Charlie flags two addition catalysts going forward.
The first catalyst will be familiar to those who revel in McElligott’s work. Here’s an update on Charlie’s CTA model which was the source of vociferous debate early last month:
The current “Max Short” in the majority of Global Equities futures largely remains (Spooz, Russell, Nasdaq 100, Nikkei, HSCEI, KOSPI all -100%); HOWEVER, we are increasingly nearing COVER levels with significant $ to BUY; and some of this covering is already indicated by the Nomura CTA Model, showing a meaningful reduction in the scale of the shorts yesterday for Eurostoxx, DAX, FTSE, CAC, Hang Seng and ASX–all now reduced to just -80% Short
So there’s that. More interestingly, he notes that assuming equities do end up gapping higher still, we could see the “return of ‘mechanical’ vol. selling flows from Systematic roll-down strategies.”
“This is significant as a 2nd derivative catalyst going-forward because Systemic Vol funds who play UXA roll-down have been mechanical buyers of vol since the curve first kinked / inverted three+ months ago”, he writes, adding that “IF we finally see this jump move higher for Stocks and the VIX curve then normalizes ‘upwardly-sloping’ again, we will then see this ‘Long Vol’ stance unemotionally pivot back to SHORT VEGA, per their models.”
That, Charlie writes, isn’t just important from an “optics” perspective. Rather, it matters “quantitatively [and] fundamentally too” given that “VIX (a proxy for generic ‘risk aversion’) is a top three macro factor price-sensitivity across the current asset spectrum per the Quant Insight model—registering as a top price-driver in 10Y BTPs (Sovy risk), SPX/ NDX /SXXP / NKY/ MXEF / HSCEI (Equities risk), EURJPY (FX risk) and JNK (Credit risk).”
Now let’s just drive this all home, shall we? At the end of his Wednesday note, McElligott implores you to scan the above list of drivers for major assets and note the preponderance of “inflation expectations” and “energy”.
Well, as I write these lines, crude just closed in a bull market, up a ridiculous ~23% from the December lows.