Nomura’s McElligott: Early Summer Melt-Up ‘Most Likely Scenario’ Despite ‘Spectacular’ Global PMI Destruction

The Sino-US trade truce was enough to buoy global risk assets in the new week, but the sugar high is set against a foreboding economic backdrop accentuated on Monday by a deluge of poor PMIs, which together serve as a stark reminder that the world remains mired in a fairly deep manufacturing slump.

On the heels of lackluster prints out of Asia, the numbers from Europe were similarly uninspiring. As Bloomberg recounts, “Switzerland saw manufacturing shrink the most in seven years, Spain registered its worst reading since 2013, overall euro-zone manufacturing shrank for a fifth month [and] in the UK, the reading dropped to a six-year low”.

Read more: Risk-On, But For How Long? The Data Is Dour

Perversely, this could be “good” news to the extent it means rate cut bets will remain sticky despite ostensible progress on trade.

“Monday brought another atrocious round of Global Manu PMIs… with 21 of 22 releases thus far declining versus the prior month capturing the spectacular breadth of the global economic deterioration”, Nomura’s Charlie McElligott wrote in a Monday note, before explaining the read-through for the easing narrative as follows:

So, despite this locally positive G20 outcome, we are seeing virtually no adjustments to the market’s already remarkable “Fed rate cut” expectations, still  at approx. 100bps of easing looking-out over the next 1Y (although odds for a July 50bps cut now are down below 20% vs nearly 40% at the start of last wk)–because the market knows that “when the Fed goes, they go hard and fast” (i.e. of the last four easing cycles, 70% of the aggregate “easing” has occurred within the first six months of the initial cut), especially with the potential for negative “business investment” sentiment to remain high as legacy trade-tariffs stay “in-place.

Between expectations for rate cuts, cautious optimism on the trade front and, importantly, under-positioning, McElligott says the “most likely early summer scenario” for US stocks is a melt-up.

The numbers will be familiar to anyone who has followed along with the YTD narrative. It’s an “unloved”, “flow-less” rally characterized by a lack of participation (depending on how you define “participation”) from key investor cohorts.

“Street PB data showing median Equities HF ‘Net Exposures’ at sub- 10th %ile ranks across 1-, 3-, 5- year ranks, we see extreme Leveraged Fund ‘Net Short’ positioning in US equities futures [and] within the overall make-up of underlying portfolios, we continue to see a very ‘Slow-flation’/’end-of-cycle’ lean from both mutual- and hedge- funds being heavily ‘Low Vol’ (long / overweight the ‘Duration-Sensitives; of Defensives- and Secular Growers- vs short / underweight high-beta Cyclicals)”, Charlie goes on to write.

The Long/Short crowd’s beta to the S&P is still bumping along at just the 3rd %ile since 2003 and McElligott describes Macro funds’ exposure as “similarly ‘meh’” at just 56th %ile over the same look back.

(Nomura)

As far as flows go, you know the story, but just in case, the latest EPFR data shows some $138.4 billion in redemptions from global equities funds, with the breakdown betraying a net outflow of -$41.2 billion in US funds (-$83.0 billion from Active-, partially offset by +$41.8 billion inflow to Passive).

(Nomura, EPFR)

Again, the read-through is that the risk is skewed towards a melt-up scenario as the same old “force-in” narrative underpins the bull thesis.

“There is significant ‘High Cash’ component which could act as fodder for a grab-in across both risk assets (and further into bonds), with money market funds experiencing a massive +$195.8 billion inflow YTD, which is 93rd %ile since 2000”, McElligott goes on to write.

As a reminder, the latest edition of BofA’s closely-watched global fund manager survey showed cash levels surging to 5.6% from 4.6%, the biggest jump in cash since the 2011 US debt ceiling crisis.

(BofA)