Anybody catch a glimpse of a convincing narrative on Wednesday?
No? That’s ok, because there really wasn’t one.
But “stocks touch four-month highs for no discernible reason” isn’t a headline anybody is going to run, so we’re stuck with a confusing mishmash where the incoming data underscores a “Goldilocks” take on the US economy (better-than-expected capital goods print, cooler-than-expected PPI) and another farcical day in London begets “relief” that Brexit has been pushed out (sterling rallied the most since April 2017).
That, apparently, is enough to trump Boeing’s trials and tribulations and ongoing signs of weakness in Asia. And all ahead of the BoJ and critical data out of China.
Here’s a largely pointless chart of the S&P, which has wiped out losses from last week, when the index dropped the most since mid-December.
A couple of things that actually are worth noting here – on Tuesday afternoon, we contended that two of the only things that matter right now are the dollar and the outlook for Chinese stimulus. Specifically, we said this:
So, what you’re seeing (and what you’re going to continue to see) is price action driven in part by the dollar and in part by headlines out of China, whether that means top-tier economic data or clarity on the scope of Beijing’s stimulus efforts, both monetary and fiscal.
On the greenback, the DXY is on track for its worst week since August (oil surged Wednesday), and while we can go back and forth on what constitutes “bad” dollar weakness versus “good” dollar weakness, the bottom line is that when the greenback comes off, it’s generally a good thing for the nascent “reflation” story and for financial conditions more generally.
The other necessary ingredient for a sustainable “reflation” trade is a concentrated stimulus effort/reinvigorated credit impulse from China (as noted above and as pounded into your skulls in these pages over the past two+ months).
On Wednesday, in his daily missive, Nomura’s Charlie McElligott cites his colleague Ting Lu in arguing that the absurd YTD rally in Mainland equities is actually counterproductive to the extent it effectively holds Beijing back from providing more monetary easing for fear of creating another 2015-esque stock bubble.
Here’s the “problem”:
That’s obviously ridiculous and the last thing Beijing wants is to see a rerun of the 2015 crash. Have a look at the last two months for the ChiNext and do keep in mind that March’s 10% gain on the small cap/tech gauge is after a near 5% rout on Wednesday (that is, it was up nearly 15% this month following February’s insanity).
If you pile another RRR cut on top of that (let alone a benchmark cut), the risk is that you pour gas on the fire. If you know anything about China’s retail investors, you know that a 25% rally can turn into a 40% surge in the blink of an eye, and at that point, it’s too late.
Now, let’s get to McElligott.
“So back to that point on Chinese easing /stimulus-escalation being a likely requirement for any sort of ‘reflation’ theme to work beyond a tactical trade, Ting Lu this morning notes that yes, more RRR cuts are coming eventually, but that the timing of such a cut is primarily dependent on the Chinese stock market, as the ‘re-bubbling’ happening real-time in Chinese Equities likely constrains the room and pace of Beijing’s policy easing / stimulus”, Charlie writes, adding that “the Chinese equities rally is effectively holding further RRR cuts hostage.”
If you accept the premise (which you pretty much have to, because where else is a meaningful reflationary impulse going to come from?) that more easing from China is a prerequisite for the reflation narrative to get any real traction, then the above “could become a serious ‘fly in the ointment'” if you’re playing that narrative for anything other than a tactical trade, Charlie goes on to say. He then warns as follows (again, citing his colleague):
Q2 is on-pace to see a significant liquidity shortage [and] Ting estimates the liquidity gap could reach ~ RMB 1.7T in Q2 due to the following factors:
- The size of the upcoming MLF maturities (est to be ~RMB 1.2T in Q2);
- The size and pace of (both central and local) government bond issuance (Nomura ests a target of ~ RMB 1T for Q2);
- Tax season effects; and
- The shortage of money supply through the PBoC’s FX purchases
Perversely, then, Chinese equities might need to selloff in order to make Beijing comfortable with adding more liquidity, something the world could desperately use right about now.
So, that’s pretty interesting, isn’t it?
Of course readers are especially keen on any update with regard to Charlie’s “March surprise” thesis, and if you’ve been following along, you might recall that he’s been suggesting for weeks that stocks could rally into options expiry. He reiterated that on Wednesday.
“The ‘March Surprise’ window-for-stock-pullback scenario has of course anticipated this type of ‘melt-up’ into Friday’s options expiration, as that’s the seasonality of ‘up into OpEx, down out of OpEx'”, he writes.
Again, the idea here is that the “down-out-of” seasonality may conspire with extreme greeks (if you will), 75% of the S&P being in their blackout window and CTAs becoming sellers as pivot points are pulled mechanically higher by the weight of the 1Y window in Charlie’s model. Here’s the OpEx seasonality going back to 1993:
And here’s an update on the sell trigger levels, which, again, will be pulled higher by the model, meaning it wouldn’t take much of a move lower (in stocks) for CTAs to turn sellers: