We’re in the midst of a “sea change” and an equities “force-in is well underway”.
That’s the message from Nomura’s Charlie McElligott on Friday, as US stocks gun for one of the best weeks of 2019, a development which, if cemented, would snap a horrendous string of weekly losses.
The catalyst for Friday’s early good vibes was yet another incrementally upbeat daily briefing out of Beijing, where various ministries are keen on driving home the idea that negotiations are alive and that talks are set to proceed despite recent bombast and escalations.
For McElligott, there’s now a “non-zero probability” of another tariff delay.
The optimism around recent conciliatory rhetoric from both sides in the trade war “has set-off an explosive under-positioning scramble, which is now being further ‘sling-shot’ higher by $Gamma impacts on illiquid pre-Labor Day markets”, he writes, in a Friday note, adding that “with cleaner Dealer positioning and some lumpy strikes at 2950, 3000, 3025 and 3050 strikes, it’s increasingly ‘$Gamma Gravity’ time”.
Getting a bit more specific, Charlie details “why we’re approaching 2,950 and why 3,000/3,050 are very much in play” on the S&P into next month’s mid-month expiry.
An updated dealer gamma positioning chart shows we’re squarely in the benign long gamma zone, which Charlie reminds you acts as a “shock-absorber” that should, all else equal, “help us ‘get sticky’ into the big upside strikes”.
Elaborating further, McElligott employs his trademark flare to chronicle the action and hint at what might be next. (If you imagine his daily missives read aloud in that deep voice from theatrical trailers, it’s highly amusing.)
“Current ‘gravity’ has pulled-us near the 2,950 strike in a vapor-trail, where we see $3.4B of $Gamma”, he details, adding that the “upside strikes which are very much ‘in-play’ from here into September 21st expiry [are] $3.9B at the 3000, $1.5B at the 3025 and $2.5B at 3050”.
This all feeds into his running thesis about an upside move into mid-month catalyzed by, among other things, the rolling of ITM calls from overwriters and corporate management rushing to get in some buybacks ahead of the blackout window. The back-half of the month is another matter, though.
As summarized here on Thursday, if the good vibes from newly-calm trade rhetoric and the impulse from the two catalysts mentioned above manage to push realized vol. lower, that could prompt re-leveraging from vol.-control funds and other systematic strats. Throw in a fundamental/discretionary crowd that would presumably be compelled to up their net exposure from current levels (in just the 1st percentile going back nearly a decade, according to Charlie) and you’ve got the recipe for a move higher.
After running through an update on the CTA model, McElligott recaps the latest EPFR flows data, and that brings up another possible catalyst. “Besides the usual massive [inflow] into fixed income and outflow from equities, there was an important ‘change of trend’ in this week’s numbers”, he writes.
Specifically, the week saw an outflow from money market funds, the first in some three months.
Why does that matter? Well, because that’s potential dry powder and it may signal something about investor psychology.
“There is a potentially massive ‘source of funds’ into any capitulatory grab-back-into risk assets on this further sentiment stabilization, particularly with the +++ ‘buy’ flows noted above for US equities into mid-September”, Charlie goes on to say.
This all comes with the usual pair of caveats, the first being that in the back-half of September, several of the bullish catalysts for equities mentioned above roll off (by necessity and by definition vis-a-vis buybacks and expiry) into a possible Fed disappointment. Unlike the highly-engaging style McElligott uses to pen his wildly popular daily missives, Jerome Powell’s “plain English” isn’t a crowd pleaser and his press conferences have a horrendous SPX track record. The stakes have never been higher headed into next month’s FOMC, and there are plenty of reasons to believe Powell might fumble the handoff.
The other risk is obviously just that “good” Trump – a man who is “friends” with “the highly respected” President Xi – flies into a rage, steps into the phone booth and emerges a couple of tweets later donning his “Tariff Man” costume.
Place your bets.