As is custom whenever there’s a dearth of identifiable catalysts and/or a lack of a discernible narrative, folks were falling all over themselves on the first day of the new trading week to “explain” the “dramatic” move higher in US equities on Monday.
And by “dramatic”, I mean US stocks rallied an “astonishing” 1.5%.
Yes, that was the best day in a while, but hopefully you can appreciate why someone like me – whose “very large brain” is often busy pondering issues that are actually some semblance of interesting or important – tends to scoff at the sheer blatant absurdity inherent in spending more than a couple of minutes trying to identify the catalysts for a 1.5% move higher in the S&P.
Fortunately, Nomura’s Charlie McElligott actually has something interesting to say about price action to start to the week, where that means he’s able to provide some context that goes beyond the obligatory, generic banter that formed the basis for every “5 theories about why stocks rallied on Monday” story you were unfortunately subjected to.
Specifically, Charlie puts things in the context of his “Ides of March”/”March surprise” thesis, which we’ve detailed exhaustively in these pages over the last two weeks courtesy of excerpts from McElligott’s daily missives.
Read more on the ‘Ides of March’ risk
“Lots of questions about yesterday’s behavior in Equities, which continues to ‘fit’ my previously laid-out vision for how the month would proceed”, Charlie writes on Tuesday, before making a “few points from the flows perspective.”
First, he reiterates the seasonality around options expiry, noting the “trade up into quarterly OpEx, trade down out of it” dynamic and reminding you that this “sits at the middle of [the] ‘March Surprise’ thesis.”
He continues, noting that a “mechanical buying of delta due to Overwriters ‘rolling-out’ is synching-up with corporate buyback flows, which typically run at a massive pace this week” ahead of the blackout period. Recall this chart from last week:
He calls this a “demand double-whammy” and at least partially attributes any rally to those two flows catalysts.
McElligott goes on to cite a kind of “bad news is good news” narrative, where the NFP miss and lingering signs of PPI deflation in China (something we mentioned over the weekend) should underscore the need for dovish monetary policy/more stimulus. He also mentions the Powell 60 Minutes cameo and yesterday’s news that December retail sales were actually even worse than originally reported.
“The weak headline NFP print and negatively-revised prior retail sales further confirmed that the Fed will be out of the picture with regards to further ‘tightening risk’, unless we were to see a ‘positive shock’ in US Growth or particularly, inflation data, as the data remains ‘not too hot, not too cold'”, Charlie muses, before addressing the drop-off/payback in China’s February credit growth data which, in combination with PPI and CPI weakness, portends “more stimulus” from Beijing and heightens “easing escalation expectations from the market in the months ahead”.
So, what does this mean for the “March surprise” thesis? Well, again, it’s still in play and for those who need a refresher, Charlie rehashes/summarizes it via the following handy bullet points on Tuesday (and these are verbatim, formatting and all):
- HOWEVER and into this Friday’s Quad Witch OpEx / through the back-half of March, I continue to see the following convergence risk as the “window for a Equities pullback,” especially after the relief seen yesterday pulled some folks back-in / forced-covering:
- In similar fashion to the flows experienced in US Equities last week, the risk of further mechanical deleveraging / selling from Systematic Trend looking-deeper into March remains, as 12m window pivot levels once-again moving higher (thus easier to trigger “selling” again on even just a smallish pullback in the broad tape)—looking at a period out 10d through out 17d from today as the “peak” of this mechanical risk
- As Overwriters “roll-out,” there is a lot of delta being bought into this rally as we approach Friday’s expiration…but this demand then “disappears” after expiration—thus the “up-then-down” seasonality around all serial- / quarterly- expirations
- This too would be occurring around the same time that SPX / SPY / QQQ index options are nearing “Negative Gamma” levels
- The end of March is also likely to see “standard” Equities PM behavior of “grossing-down” ahead of the upcoming EPS season
- And all of the above into the “demand vacuum” during the commencement of corporate “Buyback Blackout” into said Q1 earnings season, and reversing this week and next’s powerful demand-surge from corporates loading-up on stock into the blackout
Ultimately, Charlie notes that as long as inflation remains anchored, investors will revert to a kind of muscle memory associated with the good “old” days (read: the post-crisis years minus 2018), where central banks were free to lean on the “subdued inflation” line when it comes to persisting in dovish purgatory, effectively underwriting carry trades, etc.
The danger, as documented again here late Monday night in “The Death Of The Phillips Curve Has Been Greatly Exaggerated”, is a “rogue” inflation print. Recall what we said in that post:
This discussion invariably comes up whenever folks start to talk about the Fed using still-subdued inflation to justify “patience”. Obviously, that is the path the committee is on currently and more than a few commentators have suggested that a “rogue” inflation print (or two or three) is a risk to the extent it could force the market to start pricing back in the possibility of rate hikes. The February jobs report was interesting in that regard, as AHE printed a new cycle high.
It’s a good thing Powell and co. are willing to tolerate an overshoot. Otherwise, the market might be forced to start doubting whether this hiking cycle is in fact over. We’re going to go out on a limb here and say that risk assets would not like it if STIR traders started pricing in hikes again in the event price pressures start to materialize in earnest…
On that note, we’ll leave you with one final excerpt from McElligott’s Tuesday piece (and we would add that if it’s “cool” inflation we’re all depending on, the February CPI numbers are a welcome sign):
INFLATION UPSIDE SURPRISE will remain THE catalyst for global cross-asset volatility, as it’s almost universally doubted despite the February Jobs report showing a 3.4% gain in US average earnings, which was the most in almost a decade… The same way that “inflation overshoot” fears were THE macro driver of the US rate vol last January which precipitated the Feb US Equities “Vol Event,” any sort of “upside inflation surprise” will remain the key risk to reverse the stagnant legacy positioning seen across US Equities portfolio positioning as well.