Monday’s historic Momentum unwind showed up in some of the European equities price action on Tuesday as top-performing sectors sold off.
“We can call it cracks in the momentum story, as a lot of the highflyers are being sold while the laggards are being picked up”, Philippe Gijsels, chief strategy officer at BNP Paribas Fortis, told Bloomberg in an e-mail. He flagged “similarities” with what happened in the US to start the week.
As a reminder, Monday’s factor reversal was dramatic. Indeed, “dramatic” is wholly insufficient as an adjective when it comes to describing how anomalous it was.
Nomura’s Charlie McElligott was all over it. Before the bell, he flagged the potential for a continuation of a recent multi-day move in his “Pain Trade” index, which he explained is just the “simple ratio of a ‘Value’ factor proxy versus Momentum’”. Hours later, he sent out another quick blast which described what was taking place below the hood in US equities.
The action, documented here in real-time (see the linked post), was also picked up by Bloomberg, which quoted Charlie in a short piece.
Fast forward to Tuesday and McElligott is out with a lengthy postmortem, which starts with the following simple assessment (formatting in the original):
Yes, “wow”, and by that he means that the one-day return for his Value proxy (EBITDA/EV factor) was in the 99.7th percentile going back to 1990. The one-day return for the one-year price Momentum factor was a 0.0 (that’s “zero point zero”) percentile move. That translated into a truly insane 8.5-sigma event for the “Pain Trade”, documented here on Monday morning.
“The shock of yesterday’s US Equities factor reversals will go down in infamy alongside the August 2007 ‘Quant Quake’ and the Fed/March/April 2016 ‘Market-Neutral Unwind’ as one of the more stunning trades in modern market history”, McElligott writes on Tuesday, before noting that for Joe E*Trade or anyone tuned into financial television, it didn’t even happen. To wit, from Charlie:
And yet HILARIOUSLY, nobody watching financial TV or Joe Schmoe retail investor looking at just simple Index returns in isolation (or even a more sophisticated investor looking at the Vol complex yday) would have had ANY idea of the calamity occurring under the surface, as it was all about a blowout in sector- and thematic- dispersion which then acted to offset / “mask” the “top down” moves.
Indeed, the effort to piece this together after the fact on Monday evening was amusing to watch. There were a lot of vague references to “rotations” and lines like “it’s hard to pinpoint the exact catalyst”.
It wasn’t all that hard to “pinpoint” the initial macro catalyst – it was the ongoing selloff in duration and bear steepening impulse, carried over from last week. That rippled across consensual positioning. By the afternoon, though, the unwind clearly escaped from the lab, ran out the castle doors and charged down the hill into the village.
Indeed, the 7.7% massacre in the one-year price Momentum factor discussed here yesterday was the second-largest single-session drawdown in history going back to 1984, eclipsed only by a -8.2% bloodbath on April 4th, 2009.
Meanwhile, McElligott’s US Equities HF L/S model suffered a -3.3% performance bleed on the day, a debacle which Charlie notes is “tied for the second-worst one-day performance move for the leveraged fund proxy since the jarring 2015 ‘Growth Scare’ trade”.
The important takeaway from this is that looking ahead, it’s not an index story. Indeed, SPX forward returns on the heels of a one-day 0.5th percentile return for the one-year price Momentum factor betray a history of chop, prior to the S&P finally turning lower about six months out. The same is true if you look at forward returns for the index after massive Value over Momentum outperformance.
But when you look at what history shows for forward Momentum returns after a “shock” drawdown like that which unfolded on Monday, the picture is not pretty. In fact, it’s “horrific”, as McElligott puts it.
On the flipside, forward returns for the Value proxy mentioned above are astronomical six- and 12-months out following a one-day 99.5th percentile surge like that witnessed to start the week in the US.
What does all of this tell us about the macro picture going forward? Well, that’s obviously an impossible call to make with any degree fo certainty or specificity.
But, looking solely at forward returns on Momentum and Value as noted above, McElligott makes a couple of important observations.
First, he documents the events and conditions that preceded previous instances of -6.8% one-day Momentum drawdowns.
“Outside of yesterday, we see 3/3/16 [which was] the peak of the 2016 famed ‘market-neutral unwind’ where funds experienced a massive ‘Momentum Shock’ following the late 2015 global growth scare pivot into cyclical risk-on after the Shanghai accord/Yellen ‘weak dollar’ policy”, he recounts, before flagging “3/16/09, the GFC market bottom, 11/17/08, the post-Lehman escalation into the GFC lows [and] 12/26/2000, the Tech bubble pop acceleration”.
Second, he notes that when it comes to the forward returns six- and 12-months out for the Value factor proxy following huge days like Monday, performance (+27.1% median return in six months and +83.3% return in 12 months) is “possibly telling us that either the ‘end of days’ global growth prognostications were wrong, or that we do indeed begin to come out of Recession”.
“Either way”, Charlie says, “a BIG ‘Value outperformance’ trade begins'”.