As US stocks looked set to open down more than 6% once the curbs come off, Nomura’s Charlie McElligott says more CTA deleveraging could be in the cards.
“CTA ‘trigger’ levels for equities will increasingly matter again as we hold lower in stocks, because outright shorts are again being initiated and can thus be ‘grossed-up’ from the recently deleveraging small notional position exposures”, he writes, in a Monday morning note.
The really important point, from Charlie’s perspective, is that the legacy “‘+100% Long’ signal in the Nasdaq” is set to deleverage down to just [a] ‘+16% Long’ signal”.
(Nomura)
That legacy ‘+100% Long” was the “last of the generals” in equities, Charlie remarks, in a kind of eulogy.
The timing leaves something to be desired. “We are nearing an incredibly volatile seasonal for ‘1Y Price Momentum’ factor, where you typically see a very significant late March+++ performance dynamic… before April typically sees a powerful reversal lower in the factor performance”, McElligott goes on to say, citing data back to 1984.
The implication is that any reversal in factor performance tied to the duration trade in rates (which is obviously in full-on “head-over-heels”, “infatuation” mode right now, with the long-end witnessing a rally the likes of which nobody has ever seen), could be turbocharged, if things were to turn on a dime, as they did, for example, in September of last year, following August’s convexity event.
That’s a kind of “aside”, but it may end up being very significant next month, once we escape this current environment where US yields are just falling through the bottom of monitors and crashing through people’s desks.
On Friday, JPMorgan’s Nikolaos Panigirtzoglou reiterated that during the last week of February, CTAs likely contributed a “negative flow impulse” (that’s a pretty euphemistic way to say “deleveraging”) of nearly $400 billion. But, he reiterated that at least if you look at the average z-score of the bank’s short and long look-back period momentum signals for the S&P, “it would take another 4% decline… for the z-score to reach an extreme level of -1.5 standard deviations, which in our framework would likely trigger mean reversion flows”.
(JPMorgan)
Further, Panigirtzoglou wrote that “it would take a bigger 8% decline… to reach the -2.0 standard deviations low of December 2018”.
The message: We weren’t, as of the end of last week, at the capitulation levels witnessed during the depths of the Q4 2018 rout.
“If CTA equity positioning declines by another -0.6 standard deviations from here towards the -1.5 standard deviations level, it would imply equity selling of another $120bn”, Panigirtzoglou concluded.
In any case, it goes without saying that we’re still in deeply negative gamma territory, which means hedging flows will serve as accelerants, amplifying downside (or upside) moves.
Read more: S&P Needs To Rally 8-10% To Escape Gamma Trap, One Bank Says
“We estimate the ‘neutral’ / ‘flip long’ line far OTM, up at ~3156-58 in futures, while the options-implied Delta position remains ridiculously ‘short’ relative to spot (flips at 3156) and from a $notional perspective (-$492B, 0.9 %ile since 2013) which will keep bouts of covering rallies extremely violent”, McElligott writes.
(Nomura)
On Saturday, I reminded folks that over the past year, big moves in spot have generally come when gamma is negative. There are few exceptions to that, and last month’s post-expiry “unshackling” presaged the coming chaos.
This has become an “ad nauseam” talking point in these pages, but as you might have noticed, things have gone totally “mental” over the past two weeks, and this is one of (if not the) key contributing factor.
With that in mind, I’ll leave you with one last visual from Charlie, who shows you the “gamma shock” in US equities:
(Nomura)
