‘We’ve Squeezed The Max Amount Of Blood From The Stone’: Why Nomura’s McElligott Sees A ‘Re-Correction’

In keeping with the notion that “the thrill is gone“, Nomura’s Charlie McElligott is out on Tuesday morning calling for stocks to “begin their re-correction”.

As detailed earlier, the “the worst is behind us” narrative for growth (viable as of early Monday) has now turned into “it could easily get worse” (thanks to the IMF’s updated outlook), while the trade narrative has seemingly now shifted from “tariffs are about to be lifted, China prepared to eliminate imbalance” (viable as of Friday) to “oh, that’s right, nothing concrete has actually been agreed, and it’s unrealistic to expect structural issues to be resolved by the March deadline” (in play as of Tuesday morning or at least until the next “upbeat” headline).

“I see scope for Spooz to revisit 2525 level over the next two weeks with tactical longs now turning SELLERS after hitting targets last week and Systematic Trend now far from ‘covering trigger’ levels”, McElligott writes this morning. Here’s where things stand as of now (in case you’re having trouble looking at a chart).

(Bloomberg)

The bit about trend followers being far from ‘trigger’ levels, refers to Charlie’s contention that any short covering from CTAs in US equities has already played out and that we’d need to move considerably higher for any further re-leveraging to be “live” (as he’s fond of putting it). Here’s the latest set of visuals from him on that (these are from Friday):

(Nomura)

Charlie is obviously a lot more “dynamic” (if that’s the right word) when it comes to this discussion, but it’s worth noting that in the latest edition of Flows & Liquidity,  JPMorgan’s Nikolaos Panigirtzoglou noted that both the shorter- and longer-term momentum signals for US stocks were close to flipping.

“The shorter-term signal turned long again for the first time after turning short on Oct 10th joining the bullish shorter-term signals for Eurostoxx and MSCI EM, while the longer-term signal is also approaching a turning point, suggesting that CTAs are close to increasing equity exposures again after the capitulation in December”, Panigirtzoglou wrote.

(JPMorgan)

Getting back to McElligott, he says that from where he’s sitting, “the fundamental basis for a US Equities ‘tactical trade LOWER’ has strengthened.”

Specifically, he muses that we’ve “already squeezed the maximum amount of ‘blood from the stone'” when it comes to the trio of “qualitative macro catalysts” he flagged when he called for a tactical rally in the third week of December. “Now, those catalysts which ‘sparked’ the under-positioning rally have already near-term ‘realized'”, he says, before briefly discussing them as follows:

The Fed cannot pivot “more dovish” without a major degradation of US data, while “QT” powers-on undisturbed despite the predictable “forward guidance” rhetoric from Fed speakers that they are open to adjusting if required;

The PBoC “spasming” further escalated with last week’s liquidity-injections, fresh tax cuts and “special bonds” for infrastructure flurry–yet no true “nuclear” option yet  via rate cuts and deregulation of property markets;

And finally, “positive leaks” from the US / China trade negotiations reached their zenith last week, with the two stories trial-ballooned regarding the story on Treasury Sec. Mnuchin’s willingness to ease tariffs and the Chinese offer to close the trade gap by 2024 -stories either being outright denied or met with skepticism from US trade sources

Meanwhile, the econ isn’t great. Charlie flags the Citi Asia Pac surprise index sitting near the lowest levels since March of 2016 and the Europe gauge now back to the lows seen last year following the Q1 data “crash” across the pond that raised concerns about the timing of the ECB exit (that was prior to Draghi’s “rabbit out of a hat” forward guidance trick).

(Bloomberg)

He then reiterates that we’re a long way away from the next “trigger” points for his CTA model.

“The critical ‘tie-breaker’ flows of the short-term Systematic Trend / CTA community have already adjusted their prior ‘Max Short’ in Global Equities which was built across December 2018, yet since reduced in scale/short-covered and contributing to the powerful rally in Stocks since Dec 24th”, he writes, before driving the point home as follows:

Now, those positions currently sit ~ “-87% Short” instead, with no further covering to be triggered without a very significant move higher–as it stands today with levels held “static,” next CTA cover in SPX would not occur until we close above ~ 2728 in SPX…meaning CTAs are in “no man’s land” here and effectively “out of the picture” / no longer generating “buy cover” flow.

That’s a description of what you see in the charts shown above (the visuals with the red shaded areas and the blue dots).

On option hedging flows, Charlie delivers a double-dose of potentially bad news – namely that while “dealers will likely generate counter-cyclical flows to the keep market ‘pinned’ at strikes north of 2600”, a break below 2,600 means net gamma “again pivots negative, which means there is a risk on a break below that dealers will be forced to accelerate selling the lower we go.”

(Nomura)

And so, there’s (some) of the rationale for McElligott’s “re-correction”/stocks “should” head lower in the near-term, thesis.

Based on a historical analog (from 2007-2008) he’s been talking about over the past week, we “should make a ‘local low’ around Jan 31st / Feb 1st”, he adds, summing things up.

After that, the buyback bid will resume on February 6 helping to “commence another multi-week rally thereafter.”