Last week, Nomura’s Charlie McElligott outlined the “Ides of March” risk for equities.
Long story short, Charlie described what he called a “developing scenario” characterized by seasonality around March quarterly options expiry and a potential pivot point in his famous CTA model.
“We typically see stocks trade up into, then trade down out of massive quad-witch ‘serial expiry’ (this year on March 15th)”, he wrote, before suggesting that this is especially critical right now because it will collide with i) three quarters of the S&P being in the blackout window, and ii) potential sell flows from trend followers.
On Tuesday, McElligott revisits this, providing a bit more granular detail on the CTA side of the equation.
“The CTA Trend model’s US equities extremely over-weighted 1Y window [could] mechanically see its sell-trigger levels pulled higher on account of last year’s ~8% rally in US stocks from [the] Feb 7th lows until [the] mid-March Op-Ex local highs”, he writes, before noting that this dynamic is “indeed kicking-off in the coming-days and thus moves us closer to triggering systematic trend fund deleveraging looking out ~two weeks if we then were to see even just a marginal pullback from current levels [tied to the] post March Op-Ex pullback phenomenon [and] the commencement of corporate buyback blackout at [the] same time.”
Currently, Charlie’s model shows CTAs “Max Long” across myriad global benchmarks, including the S&P, the Russell, and the Nasdaq. For now, current levels on the US indices are well above sell trigger levels (on Nomura’s model), but given how critical US equities are when it comes to the signaling effect for global risk assets, the prospect that those trigger levels will be pulled mechanically higher over the coming weeks is something worth noting for what it portends about the consequences of a even a shallow selloff.
“For example, over the next week we’d expect the ‘pivot / sell level’ move up nearly 50 handles, and over the next two to three weeks, expect to see the ‘sell level’ leap a very significant 90 handles closer to ATM, meaning we’d be at risk of seeing this very leveraged strategy turning a NET SELLER if we were to see [the] catalysts I’ve discussed over the past two weeks dictate even just a smallish pullback in index”, McElligott writes.
He illustrates the point with the following visuals (it goes without saying that these aren’t static levels – that’s kinda the whole point – they move daily):
In Tuesday’s note, Charlie goes on to talk about his steepener call, something we’ve obviously discussed at length in these pages over the past month or so.
That can play out via bull steepening on the back of rate cut bets being pulled forward as global growth continues to show signs of decelerating. Or it could play out via bear steepening on the back of, among other things, a kitchen-sink-type stimulus effort out of China. Suffice to say there’s considerable doubt about whether the latter is likely and thereby whether the nascent “reflation” trade has legs.
“Despite the recent curve steepening and tactical ‘reflation’ impulse, there remains SO much skepticism on the ‘stickiness’ of the ‘reflation’ / bear-steepening scenario”, McElligott goes on to write, adding that he includes himself in the camp that wonders whether it’s sustainable. “We would likely need to see another powerful wave of Chinese / PBoC easing / stimulus / liquidity injection to sustain anything more than a short-term ‘reflation’ dynamic”, he writes.
Overnight, the headlines out of the NPC did indeed indicate that China intends to move ahead with still more efforts to reflate, but it’s an open question whether it will be enough.
Meanwhile, the “bond love affair” (as Charlie called it last week) continues to come off, despite ever present worries about global growth.
Specifically, McElligott notes that in CTA land, the “‘+100% Max Longs’ of the past 1m+ period [are] now reduced on aggregate by approximately A THIRD to A HALF of their prior size, particularly with USD 10Y, EUR- and JPY- 10Y Bonds all now just ‘+60% Long.'”
Obviously, any fading of the appetite for DM bonds could itself be faded given the persistence of the global slowdown narrative.
All in all, the broad takeaway on Tuesday is that the “Ides of March” thesis McElligott outlined last week looms on the horizon and as noted earlier Tuesday, it seems likely that a lot of folks have missed the YTD risk asset surge. That sets the stage for any latecomers to get burned badly on any FOMO tendencies they may be inclined to indulge between now and the end of the month.