Nomura’s McElligott: ‘The Window For A Pullback Has Opened’

Ok, so if you’ve been following along over the past couple of weeks, you know that the “window” for a pullback in US equities (and, given the signaling effect of the S&P for global risk assets, possibly ex-US stocks too) is now “open”.

Or at least if you buy into the “March surprise” thesis as expounded breathlessly by Nomura’s Charlie McElligott.

Last week was obviously a standout for US stocks, which posted their best performance since November on the back of a veritable deluge of inflows into equity funds ($25.5 billion).

On Monday, the above-mentioned McElligott rolls out a series of interesting factoids about last week’s “‘manna’ for the equities flows impulse” which marked a 100th percentile moment for inflows into US stocks. That $25.5 billion was the 4th largest weekly US equities inflow in history dating back 16 years.

(Nomura, EPFR)

In addition to that, there are some OpEx “anomalies” (or not) worth mentioning. To wit, from McElligott:

• 3 of the top 5 US Equities weekly inflows in EPFR history have come in the 3^rd week of March (synchs with OpEx)
• Since 2006, nine of the weekly flows for March expiry are above 90^th %ile Equities inflows
• Since 2012, seven of eight March options expiry week have seen a 90^th %ile + Equities inflow (2016 being the outlier)

On top of that, you had the corporate bid ahead of the blackouts and overwriting. “We are seeing repurchase desks around the Street reference 1Q19 as THE largest notional $buyback ever, with last week particularly heavy”, Charlie writes, adding that when you throw in “systematic overwriters rolling-out ITM Calls forcing significant dealer ‘delta grab’ and systematic VIX roll-down strats again hammering vol as the VIX curve steepened to best levels seen since late Sep18, you had the catalyst in-place for last week’s US equities melt-up.”

But over the next two to four weeks, things could change.

Those familiar with this story already know the main points. The blackout window for three quarters of the S&P is coming, and there’s a “down-out-of” March expiry seasonal in play, illustrated below.

(Nomura)

In addition to that, you’ll recall that trigger levels on Nomura’s QIS CTA model will be mechanically pulled higher, meaning any prospective selloff doesn’t need to be very dramatic/deep to prompt de-leveraging from CTAs as the pivot points move closer to spot.

(Nomura)

Oh, and if you’re wondering whether there are some potentially foreboding historical analogs for anomalous inflows, the answer is apparently “yes”.

Specifically, during months since 2006 when flows were >+$19.9 billion for the month, S&P returns were -3.8% over a two-week horizon (25% hit rate) and -2.4% over a three-month horizon (50% hit rate).

And then there’s rebalancing flows to take account of as you ponder where stocks go over the next four weeks. Here’s Charlie on that:

Quarter- and Month- end pension rebalancing flows (to SELL Eq, BUY Bonds), which should be particularly significant as SPX to outperform Bonds by over 12% QTD– a 91^st %ile move since 1973 (typically this “sell Eq / buy USTs” flow begins approx. 5d to 10d prior to Quarter-end).

Finally, McElligott implores you not to forget about the fact that while the end of Fed balance sheet runoff is nigh, for now the ongoing QT impulse is still in effect and MBS runoff (widely viewed as the more important mechanical bearish impulse for risk assets – see here and here) will “increase meaningfully” at the end of this month (-$8.7B March 20th week / -$8.6B March 27th week).

But while the window is open for a pullback, there’s a caveat. With key investor groups still underexposed, the irresistible FOMO urge may ultimately prevail.

“With obvious continued under-positioning and thus significantly ‘under-exposed’ to this ongoing Equities re-rack, I would expect any potential pullback over the next 1m to be shallow and likely ‘get scooped’ on account of performance FOMO”, Charlie adds.

We’ll leave you with his quick rundown of that under-positioning/under-exposure although really, readers should be well-apprised of this – we’ve been over it a thousand times if we’ve been over it once.

1. Fundamental L/S (HFR Equities HF Index “20d Beta to SPX” at just 39%)
2. Macro HF (Macro Fund “Beta to SPX” at just 9^th %ile per internal analysis)
3. Risk-Parity investors $exposure to SPX at lows dating-back to Nov16 levels per our internal models;
4. Retail with 89 consecutive weeks of OUTFLOWS per EPFR