The good news is, “funds have become more dynamic [and] sophisticated with their unwinds to reduce their often times ‘heavy handed’, price-insensitive de-risking”, Nomura’s Charlie McElligott writes on Wednesday morning, a day after one of the worst sessions for US equities of the year.
The bad news is, that newfound “sophistication” (which presumably helps alleviate some of the bad optics when the media is looking for selloff scapegoats) means “there will likely be additional days-worth of deleveraging flow both from the massive Asset Manager ongoing de-risking / profit-taking in their US Equities Futures ‘Longs’ as well as Trend ‘Longs’ in SPX also reducing [after] triggering yesterday and selling down from +100% to +60%, as the signal flipped in 2w and 1m models”, he continues.
These are Charlie’s follow-up thoughts after his Sunday warnings about a potential “tipping” over in the equities supply/demand picture appeared to play out on Tuesday amid suspected profit-taking from asset manager longs, benchmarks sliding below key trigger points for CTAs and the dreaded negative gamma flip – and all as the VIX curve inverted.
Read more: Nomura’s McElligott ‘Rubbernecks’ Tuesday’s Crash, Says ‘Flow Risk’ Is Materializing
On Wednesday, McElligott warns that in addition to knock-on de-leveraging that would be expected anyway, we now have to take into account the risk of new tariff-related headlines which he warns “could dictate mechanical de-risking driven by Vol Targeting strategies in the coming days [the] majority of whom have yet to mechanically- or dynamically- de-leverage”.
According to Wells Fargo’s Pravit Chintawongvanich, the vol.-targeting crowd likely had to trim their equity exposure by roughly $10 billion thanks to Tuesday’s move. “That’s still fairly small compared to the de-risking in October, when the sudden 3.3% move sparked over $100 billion to de-risk in these strategies in a fairly short time”, he wrote. Another 2% down from Tuesday’s close would entail an additional $12.7 billion in de-risking while a 3% drop would mean some $36.1 billion in trimmed exposure.
We’d need to see “a few days of ‘sticky vol,’ which then can pull trailing realized higher” for this pan out, McElligott wrote this morning.
For what it’s worth, here’s a decent benchmark for vol.-control – the point is, “escalator up, elevator down”.
(Bloomberg)
After noting that eurodollar upside looks like “smart protection” right now (especially in light of the fact that a meaningful and sustained escalation in trade tensions would likely make the Fed more inclined to bow to market pressure and cut rates), McElligott notes that vol. is either too high or else stocks should be much lower. To wit:
The aforementioned point on VVIX- and Skews- still at such extremes obviously iterates the outperformance of VIX vs S&P; i.e. per the previous two year lookback as “standard,” yesterday’s SPX performance “should have” seen VIX close at 15.95–but instead, it closed at 19.32 (and +47.3% WoW), which captures the relative extremes of the “short vol” unwind which behind the VIX futures curve inversion.
Charlie goes on to note (bottom pane above) that we’ve just seen the second-biggest three-day move in the VVIX/VIX ratio since Vol-pocalypse. The only more dramatic episode was Steve Mnuchin’s hilarious Sunday evening “liquidity” SOS call to bank CEOs.
Now then, if you’re wondering whether McElligott is buying into the notion that the bounce off the lows on Tuesday and relative calm overnight (at least until the Reuters story crossed) was due to “trade calm” or some other lazy, generic excuse cooked up by a weary journo, the answer is “no.”
“Despite silly headlines later from financial media, yesterday’s bounce into the close and the initial overnight follow-through was not about some sort of tariff / trade ‘calm’ or ‘optimism'”, he chides, on the way to explaining that “it was instead the result of long vol / short delta monetization and in the larger sense, an environment where funds [and] traders are forever incentivized to sell into spikes in volatility.”
Charlie closes things out with a pretty dramatic mini-rant about metastability. You can almost hear that classic Mortal Kombat “Finish Him!” voice presaging these final epic passages from McElligott’s Wednesday classic:
- So the larger / existential question: why does this now almost quarterly “short vol / easy-carry / easy-carry / easy-carry BLOW-UP then v-shaped snapback” seemingly occur now more-than-ever before?
- IT’S PURE MINSKY of “stability breeding instability”–I will happily pin-this on the post GFC Central Bank policy response of large-scale-asset-purchases and forward-guidance on “lower interest rates and flatter curves forever” which has then perpetually suppressed cross-asset volatility AS WELL AS squelched yields–all in order to create intentional “financial repression” which drives “portfolio rebalancing” ài.e. “reach for yield” via “pushing-out on the risk-curve” behavior
- As such, Real Money institutions have moved from being BUYERS of volatility and tail-risk hedges to instead turn VOL SELLERS in the post-crisis period (systematic call overwriting / put underwriting, condor- and strangle- selling, roll-down etc)–all in order to generate total return / “yield enhancement” in a world deprived of return
- As a friend wrote yesterday–ENJOY: “If you’re short vol, you make money…but eventually die. But if you’re long vol, you die before you make money.”
