Nomura’s Charlie McElligott is “excited”.
But not just because “April is booming for US Equities” as he’s variously suggested it might in some of his most recent daily blasts. I mean, he seems excited about that too, but he’s “most excited” about “the particulars”.
You might recall that Charlie has spent a good bit of time recently documenting the return of the “slow-flation”/indefinite vol. suppression narrative and the consensus trades that go along with it. The biggest risk to some of those “slow-flation” trades is obviously an inflection /repricing higher of growth expectations, something he talked about at length last week.
He picks back up on that Tuesday and these are the “particulars” that have him so fired up. “My TACTICAL case to fade the consensual ‘Slow-flation’ narrative is now playing out –with ‘Value’ factors exploding higher (Predicted E/P +3.8% MTD; EBITDA / EV +3.5%, PEG +3.2%, Sales / Price +3.1%, E/P +3.1%, Cash Flow / EV +3.0%, B/P +2.3%), while legacy ‘Momentum’ conversely has come unglued (1Y Price Momentum -4.8% MTD, 1Y Momentum Sector Neutral -3.5%, Vol Adjusted Momentum -3.0%) as the trend trades of the past year reverse sharply thus far in April, and as the US yield curve begins a nascent ‘BEAR-STEEPENING'”, he writes, documenting the evolution of a dynamic he predicted last week as the market looked prone to latching onto to any and all economic green shoots following the late March growth scare and concurrent DM bond rally.
Remember, that growth scare and the bond rally that accompanied it was something of a Fata Morgana – a subverted perspective as convexity flows/hedging dynamics acted as an accelerant in rates, exaggerating moves and spooking market participants. We talked about that last week using a few quotes from Charlie’s Wednesday note.
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LOLz, Momentum Factor Destruction, Cyclical Melt-Up Catalysts And Another Fata Morgana
This comes up again in his Tuesday note. Here’s how things played out following the March Fed meeting (where Powell delivered another dovish surprise against all odds):
The “March 2019 Fed Rate Cut Panic” created 1) an overshoot in the “richness” of US Rates (via the negative convexity spasm) as well as 2) caused a “false optic” regarding the perceived extreme probability of a U.S. Recession–which then presented an opportunity to FADE consensual the Equities “Slow-flation” narrative, which was based on a “Goldilocks” world-view of “slowing but steady US growth and trending lower inflation” and has been expressed by place-holder positioning of “Barbell Long Secular Growth and Defensives versus Short Cyclicals”. As the Fed has obviously pivoted violently away from the 2018 volatility-inducing regime of “QE to QT,” the “NOW” collective embrace / jump the gun back-into outright “QE” thinking of lower rates and flatter curves too saw Equities investors go back to their “Slow-flation” comfort blankets–as + Sec Growth + Defensives / (-) Cyclicals has been a massive positive performance driver for the majority of the past 5+ year period
The stage was thus set for upbeat PMIs out of China and last week’s ISM beat and solid jobs report in the US to prompt markets to rethink the whole growth scare narrative or at least to consider whether we went into last week having overshot materially. Cue this (from McElligott):
Thus with global growth being re-priced HIGHER, we then see perpetually underweighted / placeholder shorts of predominantly “Cyclical” sectors having ripped so far in April (Materials +4.3% MTD, Financials +3.5%, Energy +2.8%, Industrials +2.2%) while the “Slow-flation Barbell Longs” act as a relative “source of funds”: “Secular Growth” high flyers like “Tech Momentum Longs” are -4.2% MTD; Sofware 8x’s EV / Sales -1.5% (after being +36.4% YTD LOL).
After recapping all of that, Charlie goes on to talk about underpositioning and underexposure from key investor groups, something we’ve discussed ad nauseam in these pages, most recently on Sunday evening in our traditional week ahead preview. This is one of the key pillars of a bullish thesis going forward (i.e., the notion that folks will get “forced”/”dragged” in, providing an extra impetus on the upside).
Here’s Charlie running through the numbers on that after noting that “you still don’t have many market players ‘participating’ in this Equities move to the extent they want, especially in the leveraged-fund space.”
- Equities Long-Short HF “Beta to S&P” is down to 12th %ile since 2003
- Particularly for this “Cyclical Beta / Value” discussion, Long-Short “Beta to Nomura Beta Factor” is down to just 9th %Ile since 2003
- Macro Fund “Beta to S&P” is just 17th %ile, and broadly de-risked across assets:
- Macro Funds beta to Nikkei: down to 32%tile from 33%tile (1m ago was 8%tile)
- Macro Funds beta to Eurostoxx: down to 19%tile from 43%tile (1m ago was 14%tile)
- Macro Funds beta to Crude: down to 31%tile from 37%tile (1m ago was 12%tile)
- Macro Funds beta to 10 yr yield: down to 34%tile from 40%tile (1m ago was 3%tile)
- Macro Funds beta to EEM: down to 13%tile from 27%tile (1m ago was 22%tile)
- Macro Funds beta to Gold: up to 38%tile from 35%tile (1m ago was 79%tile)
- Macro Funds beta to Euro: down to 30%tile from 36%tile (1m ago was 62%tile)
- Macro Funds beta to Dollar Yen: down to 38%tile from 48%tile (1m ago was 14%tile)
- The Nomura QIS Risk-Parity model estimates the overall $allocation to US Equities remains at a two year low
Here’s a visual on the first two points:
(Nomura)
McElligott goes on to note that $87 billion has come out of global equities funds YTD, nearly half of which in the form of outflows from US funds.
He also notes that when it comes to equity hedge funds, value being suddenly en vogue versus momentum is never a good thing (think back to October, for instance).
(Nomura, Bloomberg)
From there, Charlie notes important seasonals that could lead to a continuation of the dynamics outlined above. Specifically, he writes that “seasonality for ‘Cyclicals’… back to 1984 shows that the top two US industry SEASONAL performers (Apr05-May05) are Energy +3.5% with a 76% ‘hit rate’ (with Crude seasonality +4.1% median change over that same period and 64% “hit rate”) and Banks +3.2% with a 68% ‘hit rate’ (boosted likely by the re-opening of their ‘Buyback Windows’ following commencement of earnings later this week).”
Of course that’s just tactical in nature, which leads to the following obvious question: What could push this further and make it a sustainable fixture of the current market mode?
Well, the answer is the same as it ever was: Kitchen sink-type stimulus out of China and/or confirmation that the Fed is moving ahead with a rethink of their inflation strategy.
“It likely only gets ‘sticky’ with the potential for an escalation at some point in the next 6 months on i) not just additional Chinese easing in the form of RRR cuts, but in the outright easing of property sector restrictions, and/or ii) my expectations that the Fed will be crystalizing their shift to a new ‘inflation framework’ with regards to tangible policy voicing an intent to run a ‘make-up’ strategy, inflation averaging, or even outright ‘price-targeting'”, Charlie says.
And so, that’s where things stand if you ask McElligott, who, again, is “excited” on Tuesday – just like Monday and every other day when there’s a market open somewhere.
