Markets stocks volatility

After The Crash, Nomura’s Charlie McElligott Looks Ahead

"Peak calamity". Now what?

“Peak calamity” – that’s how Nomura’s Charlie McElligott describes Monday, the worst day for US equities since the crisis, a harrowing day for measures of credit risk and one of the most dramatic sessions for crude in the history of the world’s most financialized commodity.

On Tuesday, risk assets tried to bounce, ostensibly on promises from Donald Trump, who swears he’s set to roll out a “dramatic” (“big league”) economic stimulus package, complete with a payroll tax cut.

But, as noted before the sun was up, a lot of this action in equities is down to hedge monetization, and, relatedly, to the current, underlying market dynamic which is conducive to violent squeezes.

“Today has the feel of a standard ‘bear market rally’, where selling is increasingly exhausted”, McElligott writes, in a Tuesday note, adding that “monetization of dynamic hedging in futures shorts [is turning] into a rather violent ‘squeeze’ as the enormous ‘short delta’ via SPX/SPY options will continue to act as a ‘core’ catalyst for these raging up trades”.

As Charlie puts it, “these options ‘have to’ be monetized when they’re this in-the-money, especially as they’re expensive to roll”.


Meanwhile, target-vol. just doesn’t have much left to purge. This is something I’ve pointed out repeatedly over the past two weeks, but now, we’re at a point where after some $130 billion in pared exposure over the space of a month, this universe’s allocation is in the 1st %ile going back a decade.

“There is increasingly little left to sell and the greater risk is incremental reallocation to buy in the coming weeks”, McElligott writes.

Of course, vol. needs to reset lower and stay there in order to pull back in some of these investor cohorts. As Charlie points out, that’s going to be difficult, at least until expiry.

Assuming vol. can reset lower and we do get a convincing fiscal impulse prompting a retrace higher in yields (i.e., a rates selloff), it sets the table for a possible factor unwind in April, given that at least one key factor expression linked to the “duration infatuation” is up against a daunting seasonal next month. If bond yields were to snap-back higher after the overshoot (as they did after last year’s convexity events), it could make for an interesting scenario akin to the multi-standard deviation rotation that occurred in September.

In any case, if you’re wondering what usually happens after US equities are bludgeoned as they were on Monday, here’s a handy guide using data from Charlie’s Tuesday missive:

Oh, and McElligott also writes that when it comes to client sentiment, the word is “horrible”.


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