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Nomura’s McElligott: ‘It’s Getting Hot’, But ‘Perpetually Easy’ Fin Conditions ‘Keeps Train Rolling’

The proximate cause is no secret.

This “train” just “keeps rollin'”, Nomura’s Charlie McElligott said Tuesday morning, as US stocks persist in summiting fresh peaks on a near-daily basis, pausing only when it appears a world war might be in the offing.

The proximate cause is no secret. “Perpetually easy US financial conditions make this an ‘everything rally’ environment for investors, where risk assets / spread product should be supported by ‘firm’ USTs over the course of 2020”, Charlie writes, reiterating the notion that calls for a steep bond selloff (in true “reflation” fashion) notwithstanding, any trek higher for yields is likely to be muted by a subdued macro backdrop and the persistence of accommodation from policymakers.

That doesn’t mean McElligott is predicting a big rally in rates either. Instead, he sees a kind of QE “stasis”, as discussed at length last month.

Read more: Nomura’s McElligott Explains The ‘QE-Like Stasis’ Of An ‘Everything Works’ Market

What’s behind this “stasis” that allows the “everything rally” to persist? Well, four factors, which Charlie lays out again on Tuesday. To wit:

  • “Goldilocks” US economic backdrop with benign inflation
  • Fed reaction function clearly skewed asymmetrically (super-low bar to ease, almost impossible bar to hike)
  • My belief that the current “QE-Lite” (in that the Fed are NOT buyers of “Duration,” just short-term Bills) will transition to standard “QE” over time, moving toward towards USTs / outright “Duration” purchases in an effort to provide “ample” reserves in the banking system and offset money market stress points
  • Long-term view from investors that the “Three D’s” will continue to create secular disinflation which makes will keep policy “easy” and rates “low”—the overall 1) trajectory of Debt growth, 2) fading Demographic impulse and 3) tech Disruption

It’s hard to argue with that. We’ll get CPI on Tuesday, but as discussed here over the weekend, it’s unlikely to move the needle for the Fed.

This, in essence, is what “Goldilocks” looks like:

Stocks rallying with intermittent breaks to account for trade tensions, bonds rallying on the whole, the dollar subdued by Fed cuts in Q4, growth running around 2% (although it should decelerate going forward) and steady-as-she-goes inflation.

Meanwhile, under the hood, equities continue to benefit from options extremes.

“$13B of $Gamma at the 3300 strike in SPX / SPY options says it all, nearly 2.5x’s that of the next largest $Gamma strike line”, McElligott continues on Tuesday, adding that the next largest strike is $5.8B at 3290, “with another $5.2B at 3310 and $4.5B at 3280 all keeping us sticky ‘up here'”.

Options positions extremes are, in fact, getting “extreme-r”, to quote Charlie, with “SPX / SPY at 94th %Ile $Gamma and 99th %Ile $Delta (since ’14); QQQ at 98th %ile $Gamma and 100%ile $Delta [and] EEM at 99th %ile $Gamma and 100th %Ile $Delta”.

Is it all too stretched? Well, that’s the million-dollar question, now isn’t it? Lots of folks are drawing January 2018 parallels, despite the lack of a similar “dry kindling” setup.

For his part, McElligott notes that sentiment is “getting hot”, although backtests suggest the rally could extend out 12 months.


“Objects in motion”, and what not…


4 comments on “Nomura’s McElligott: ‘It’s Getting Hot’, But ‘Perpetually Easy’ Fin Conditions ‘Keeps Train Rolling’

  1. When sentiiment and overbought gets to current levels, the risk of something “bad” happening is high and the chances of anticipating what that “bad” will be is low. It usually comes as a surprise, at least for most of us.

    Doesn’t mean that you go screaming to all cash, but taking some off the table and shifting mix/exposures makes sense.

    I’m not a fan of making big binary bets.

  2. inflation is inching up, even if it is “low” by offical measures.

  3. I tend to be suspicious when there are too many people on the same side of the boat…In this case the cause is that all the smart people have the same narrative after a long arduous study of the facts and the relevant soul search that followed…

  4. What happens if QE infinity doesn’t lead to better economic outcomes and we just keep getting higher stock prices? Corp cash flows getting hit, eventually less share shrinkage, less investment, layoffs. Then what? Fiscal stimulus? We will all be in construction. Then deposits of cash into all bank accts.

    We are growing 2% after massive fiscal stimulus and easy money. Corp profits are flat. Corp investments (future productivity and growth and wealth) is poor.

    What happens if the economy does not respond? Still think the Fed will be able to engineer higher stock prices?

    Everyone is a whore and everything is cyclical. Sorry but true.

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