If you think back to late last year, one argument for why equities were likely to bounce following the worst December since the Great Depression, revolved around the notion that there was nobody left to sell.
Positioning had undergone a veritable purge, with the Long/Short universe having de-netted/de-grossed materially following the October rout and the systematic crowd still largely sidelined as well. Once mutual fund investors bailed en masse midway through December, the case was further made for a scenario that would see everyone “forced” in on a rally.
Well, the rally came all right, in the form of the best January for equities since 1987, but if the latest installment of BofAML’s Global Fund Manager survey is any indication, some folks are still reluctant to jump back in.
As noted here last week, a simple moving beta of the HFRX Equity Hedge index suggests the Long/Short crowd is still underexposed (top chart) and although volatility has collapsed dramatically over the past month, it hasn’t been low enough for long enough for the vol.-targeting crowd to rebuild exposure (bottom chart).
Was Tuesday’s gap higher in US stocks a sign that anyone who was sidelined/paralyzed by macro uncertainty was “grabbing” amid indications that there will not in fact be another government shutdown and that Trump is inclined to extend the March deadline for trade talks?
Nomura’s Charlie McElligott thinks the answer might be “yes.”
“The core input back in late December when I was anticipating a powerful rally at the start of January was a simple awareness of the scale of the de-grossing / de-risking in Q4 meant that a simple set of predictable macro catalysts could then cause a violent ‘grab’ back into exposure”, he writes, in a Tuesday evening note, before delivering a series of bullet points detailing exactly “how ‘under-exposed’ were/are fundamental investors to U.S. Equities”.
Here is that bullet point list (do note that it includes the data from the BofAML survey which, you’ll recall from this morning, describes a “big fat buyers’ strike“):
- 10 consecutive weeks of outflows from US Equities Funds per EPFR, with -$26.3B of redemptions over the last 4w alone and now -$40.8B YTD
- HFR Equity Hedge Fund Index with 1m rolling “beta to S&P” at just 36% (for context, was 81% in late Sep ’18)
- Macro Fund positioning proxy shows 1m rolling “beta to S&P” just 4th %ile since 2003
- Hedge Fund L/S positioning proxy shows 1m rolling “beta to Beta (factor)” just 40th %ile since 2003
- Mutual Fund positioning proxy shows “beta to Beta (factor)” just 33rd %ile since 2003
- BAML FMS highlighting the smallest “overweight” of Global Equities allocations in nearly 2.5 years, with US in particular the 2nd least favored region among money managers and overall 3% UNDERWEIGHT
- BAML FMS shows the highest “overweight” to Cash in 9.5 years
After running through the thematic breakdown (i.e., how things played out from a style/factor/sector perspective on Tuesday), Charlie reminds everyone “how we got here.”
“The market’s perception on the resumption of the ‘Fed Put’ has once again made this a ‘Risk-Parity’ type environment, reminiscent of the ‘QE Trade’ era where it was ‘long risk, long gold, long USTs and short USD'”, he goes on to write. The implication, he says, is that risk assets (e.g., high-beta equities and risky credit) “can work alongside USTs/Long duration as the Fed works to reverse prior tightening of U.S. Financial Conditions.”
Next, McElligott revisits something he’s been over on at least three or four occasions lately – namely that short vol. is back thanks to the Fed’s pivot and what he’s characterizing as a “de-facto” single mandate (i.e., a singular focus on inflation, which allows for dovishness in the current environment).
“The Fed’s ‘great step backwards’ to a de-facto ‘inflation-only’ mandate has seen the market again turn to a ‘short volatility’ stance, as there is a consensual belief across market participants that the world is again dis-inflating, and providing confidence that the Fed’s next step is to EASE policy, further seeing/driving suppressed volatility”, Charlie explains, adding that “this is occurring just as systematic vol strategies too have again moved-back into ‘roll-down’ mode, as the resumption of an upwardly sloping VIX futures curve sees them again short vega for the first time in over 4 months.”
As far as CTAs go, it’s the same story, as the systematic crowd flips back long, based on Nomura’s QIS model (more here). He also notes that his risk parity model’s estimated notional exposures are “now too beginning to turn, with +$600 million of global equities adds over the past two weeks and another +$3.2 billion in bonds.”
On the gamma gravity front, 2,750 is where the OI is concentrated.
So, what now? Well, this is “the hard part”, Charlie says.
Once everyone “grabs” or gets otherwise pulled in/forced in by an improving macro backdrop (e.g., easing trade tensions, a breaking of the stalemate in DC, more signs of easing from Beijing, etc.), the economy will dictate the outcome.
“The lagging impact of the prior Fed tightening can continue to slowly bleed into the real economy, which continues to be the reason that STIRs are pricing-in a Fed CUT in 2020 as the next move”, he writes, before noting that those who subscribe to the “stock” argument of QE (i.e., that it’s the sequestration of assets on CB balance sheets that matters most and therefore if the size of the Fed’s balance sheet is now expected to be larger than previously thought when runoff ends, things should be fine), the “flow” (i.e., the marginal, price insensitive bid) matters too. And on that latter point, McElligott reminds you that “QT does continue unabated for now.”
Finally, he notes that “MBS portfolio unwinds MATTER for SPX / VIX.” He cites the work of his colleague George Goncalves (more here) on that and we would add that Morgan Stanley has also warned that it’s the MBS runoff that matters most for risk assets. Here’s an updated QT schedule for those interested:
There you go: around the cross-asset universe in 1,000 words with an assist from everyone’s favorite rapid-fire derivatives strategist.