Nomura’s Charlie McElligott And The ‘Grabby Squeeze’

“[There’s] not a lot to debate here”, Nomura’s Charlie McElligott writes on Wednesday morning, of Tuesday’s “grabby squeeze”, which is either a description of the best day for US equities since January or the name of a super-fun new product from the makers of Capri Sun.

McElligott reminds you that he’s documented “the required inputs for a ‘squeeze-y grab higher'” exhaustively. There was, for instance, “an incredibly extreme SPX/SPY Dealer $Gamma position into yesterday morning”, Charlie writes, and “a massive grossing-up of Short books and/or dynamic hedges via futures since the start of April from the buy-side in an effort to reduce net exposure levels to nearly two-year lows.”

That latter point is down to the tariffs and the perception the trade war may tip the world into a recession. That action then “created the fodder for [the] squeeze” as crowded shorts surged 3.9% Tuesday and +4.7% on the week. McElligott notes that the most crowded shorts (i.e., the single-name basket of popular shorts) was down more than 16% from April 10 through the end of last month. In other words, those shorts were pressed hard indeed.

The discussion then moves naturally to one of Charlie’s favorite topics, the effect of the yield curve on factor behavior. Most of the shorts were, unsurprisingly, in Value and Cyclicals. Well, when you get bear steepening, you have a catalyst for Value to rip and Momentum to sink. Recall the following from Tuesday evening’s “Not-So-Lonesome Doves“:

Some folks described Tuesday’s bear steepening as an “interesting” development, but keep in mind what it is officials are discussing in Chicago — the whole point is to reassess the policy framework with a mind towards addressing inflation shortfalls. The risk to the “bond love affair”/”duration infatuation” is the reappearance of inflation, and there are three possible catalysts for that, one being a new approach from the Fed (e.g., a strategy that involves tolerating overshoots to “make up” for shortfalls), the second being the tariffs and the third being a possible kitchen-sink-style stimulus push from China. Anyway, you don’t want to read too much into one day, but nobody should forget that setup, as it’s potentially combustible.

Charlie ties this into the squeeze. “UST 2s10s broke out of range to new 8-month highs, 5s30s made new 20-month highs [and] 2s30s made new 14-month highs”, he writes, adding that “most importantly for the squeeze in Value, it was a BEAR-steepening, contra to what has largely been an 8m bull-steepener.”

(Incidentally, we’re back to bull steepening on Wednesday morning thanks to a pretty grievous ADP miss.)

McElligott goes on to remind you (for the umpteenth time over the past year) that Value factors are positively correlated with steeper curves, while Momentum is negatively correlated. He always cites the following chart from a colleague when talking about this:

(Nomura)

And so, this week has been about hedge funds grossing-down. “Losses in popular Longs then further exacerbated the forced-covering of Shorts”, Charlie writes, adding that “Monday was about the idiosyncratic anti-trust news across ‘new tech’ crushing a number of crowded positions… which likely generated corresponding ‘short cover’ flow on the other side as funds ‘grossed-down’.”

Then, yesterday, “the other side of the ‘Slow-flation’ barbell Long was hit, as tremendously over-owned Defensives massively underperformed”, exacerbating performance anxiety and thereby adding to the impetus for short covering, he continues.

(Bloomberg)

As far as CTAs go, McElligott writes that the famous QIS CTA model showed “SIGNIFICANT $ buying / covering yesterday across key SPX- (re-leveraging the ‘Long’) and NDX- (quickly covering the prior day’s ‘Short’) Futures positions with both now posting a ‘+97% Long’ signal.”

So, where to from here? Well, suffice to say Charlie goes into quite a bit of detail on “expected forward behavior” following the “brutal squeeze” in momentum shorts, and as he readily acknowledges, the discussion is “VERY nuanced” (all-caps in the original).

Ultimately, the message is that going forward, it wouldn’t be the worst idea to rebalance into (or at least tilt towards) Value and pro-Cyclical names ahead of an assumed recession and concurrent Fed easing. We would caution that this shouldn’t be taken out of context. As Charlie writes, it’s somewhat “surprising” that “Value factor works well into recession periods” and for some, that will appear counter-intuitive assuming “‘Value Longs’ are largely Cyclical.”

What you have to consider, though, is that, to quote McElligott one more time, “the initial outperformance by Value is driven by positive P/L contribution from the ‘Value Shorts’ leg, which are by definition ‘EXPENSIVE STOCKS’.”