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Nomura’s McElligott Talks The ‘Pain Trade’ And What More Bearish Rates Action Would Mean For Equities

"...the current consensus / 'Momentum' positioning construct is a pure reflection of the 'Duration Trade'".

Monday morning saw Treasurys under pressure again with the long-end leading, as bear steepening took hold concurrent with a selloff in core EGBs ahead of this week’s ECB meeting and on the heels of better-than-expected data out of the UK.

Yields were higher across the curve, with the 2s10s and 5s30s both steeper. We’ll see if it lasts.

This comes after a sideways Friday and a Thursday session which featured one of the most acute bond selloffs in years.

Wall Street is broadly bullish, although Goldman still sees 10-year yields rising around 20bp by the end of 2019.

With the duration infatuation having become so firmly entrenched, any reversal of fortunes is bound to have an impact across assets, even if any turning of the proverbial tide turns out to be short-lived.

Nomura’s Charlie McElligott notes that “a further extension of [any] bearish Rates / USTs price-action [would] be felt within the US Equities complex, because the current consensus / ‘Momentum’ positioning construct is a pure reflection of the ‘Duration Trade'”, where that means long secular Growth and Min. Vol., against short Cyclicals. This has come up time and again over the last several months – Marko Kolanovic talked about a few notes back.

So, if you were positioned for a continuation of the trend lower in yields, you experienced a “performance bleed” late last week.

“This is why US Equities ‘1Y Price Momentum’ factor has seen such a powerful burst of ‘shock-down’, -6.6% over the last week and a half after having ‘glided’ to what is still a +15.9% return YTD on account of consensual investor ‘buy-in’ to the ‘Slow-flation’ —> ‘Dovish Fed’ trade”, Charlie writes, employing his signature parlance.

McElligott has a “Pain Trade” index, defined/constructed as follows:

The simple ratio of a “Value” factor proxy (e.g. EBITDA / EV) versus “Momentum”—as “Value” is positively correlated with UST Yield Curve “bear-steepening,” while “Momentum” is inversely correlated to the steepening / US Rates selloff.

He goes on to note that the same factors driving the selloff in duration have catalyzed a better than 16% return in the ‘Pain Trade’ over the past week and a half. More than 9% of that has come in the last three sessions alone.

(Nomura, BBG)

Long story short (and there’s a market pun in there somewhere), that’s Momentum longs/Value shorts getting caught wrong-footed, McElligott writes.

He goes on to say that this has been “doubly frustrating for many investors” to the extent they got the overall index directional trade correct, “but just as hedge funds slashed net exposure again and/or pressed Futures ‘shorts’ [while] vol. got destroyed Friday [meaning] peoples’ hedges didn’t offset these losses either”.

(Nomura)

He also calls late selling on Friday in some crowded longs (e.g., Tech) “notable”. “[It] looked like we were beginning to see some of that hedge fund ‘Gross-Down’ flow, and ‘longs’ were finally being reduced alongside ‘shorts’ being violently covered over the prior sessions”, he remarks.

Still, Charlie’s overall, near-term outlook remains largely the same – namely that a series of flow catalysts drives equities higher into mid-month, at which point stocks come up against the possibility of central bank disappointments just as those flow catalysts disappear into the late summer haze.

Read more: Nomura’s McElligott Talks US-China Trade News, September Sequencing For Equities

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