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.
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…