Predictably, markets start the new week torn between “wanting” to extend the YTD risk surge on the back of the dovish Fed pivot and “recognizing” ongoing signs of economic malaise, courtesy on Monday of China’s December trade data which was obviously a disaster.
Adding to consternation were Citi’s grievous FICC results, which betrayed a 21% swan dive in FI trading revenue in Q4, suggesting that while volatility might have been a boon for some bank results early in 2018, last quarter might have been a different story.
On top of all this, the US government shutdown drags on and Donald Trump is fighting to convince America he’s not a Kremlin operative (sorry, but it never gets old).
Oh, and the Brexit drama is casting a pall as well.
Nomura’s Charlie McElligott is out with some quick thoughts on Monday morning, touching both on the ramifications of China’s ongoing economic deceleration and also on last week’s “grabby” behavior (as he’s fond of putting it) from the Long/Short crowd.
As we noted on Sunday evening and reiterated first thing Monday, crashing exports/imports will invariably stoke expectations of (more) easing from China, which means last week’s yuan rally could prove fleeting. It also suggests bad news could be “good” news if it means pushing Beijing closer to the “kitchen sink” moment vis-a-vis a wholesale reflation push.
“Beijing will perhaps be more eager to strike a trade deal with US [and] policymakers will need to take more aggressive measures to stabilize GDP growth”, McElligott writes, adding that “these economically growth-negative data-points actually push us closer to the point of risk-asset positive policy capitulations from the Chinese.” They need to hurry.
On last week, McElligott reiterates the “grab”, noting that “equities Mutual- and Long/Short- Funds both grabbed meaningfully back into US Stocks, increasing their beta to SPX WoW.”
He continues, adding that “Mutual Funds’ beta to SPX is up to the 62nd %ile from 59% last week, but more glaringly, buying the dip and SHARPLY up from just 27th %ile 1m ago.” Meanwhile, Long/Short hedgies’ beta to SPX also “jumped last week to 52nd %ile from 41st %ile,” but Charlies notes it “remains significantly lower from last month’s Santa Rally positioning blow-up (was 81st %ile 1m ago).”
Critically, he says the Long/Short crowd is upping their nets via “forced-reduction” of short books, which “were obviously grossed-up in December as the market melted and are now being painfully squeezed-out to start 2019, outperforming Crowded / Popular / Momentum Longs by 2x’s – 3x’s YTD.” That’s clearly worth bearing in mind and here’s the accompanying visual.
Perhaps more notable is the read-through of surging crude prices dragging breakevens higher after being bled dry late last year. We’ve been over this a thousand times if we’ve been over it once and it’s a critical piece of the puzzle, especially as it paradoxically plays out against worsening growth data.
“Both the Quant-Insight short- and long- term models for the S&P 500 are showing that higher ‘Inflation Expectations’ are once again the largest positive price-driver for US Equities, and actually show ‘IE’ with the highest sensitivity to SPX of the past 4 year period, which notably includes the entirely of the ‘Shanghai Accord’ / ‘Trump Reflation’ trade regimes”, McElligott goes on to write.
Of course this could all turn around in a heartbeat to the (likely) detriment of risk sentiment. Charlie underscores that, noting that “5-year Breakevens remain stuck near at multi-year lows as skepticism on ‘reflation’ remains extraordinarily high, so any reacceleration of Crude downside / resumption of downward pressure on Inflation Expectations will be an unequivocal negative for Equities.”
Right. And while the bounce in crude and concurrent recovery in breakevens looks impressive on a three-week chart, panning out tells the story.
Meanwhile, the quandary remains: the Fed’s dovish pivot eases financial conditions and bolsters risk assets, but what does it “say” about what the committee thinks re: the effects of the tightening that’s already happened?
To that, McElligott notes that “a continued fading of US economic trajectory will drive a further move lower in US real yields as confirmation of ‘end-of-cycle’ fears, with the lagging impact of prior Fed tightening reverberating throughout the economy.” Generally speaking, that informs his contention that bull steepening should be seen as a risk- negative signal.