Nomura’s McElligott Talks Flow Catalysts As VaR Shock Fades, Markets Eye Stimulus, Recession

Early Thursday, following the release of the most hotly-anticipated weekly claims report in history, some suggested the Labor Department should thank economists across America, and also local officials, for spending the past week obsessing over the incoming state-level data.

The irony, I wrote, is that the market was expecting the figure (an astounding 3.283 million print) thanks in no small part to state-level reporting in apparent defiance of the Labor Department’s “guidance” to keep quiet. That, in turn, may mean the market impact of the figure is muted, even as it underscores just how dramatic the real-world impact of the coronavirus containment measures has been.

For what it’s worth, Steve Mnuchin called the data irrelevant – and yes, I’m serious. “[It’s] not relevant”, he told CNBC. “The president is protecting those people”.

I don’t know, Steve, it looks pretty “relevant” from where I’m sitting which, by the grace of a higher power or, more likely, dumb luck, is in a much more comfortable spot that the 3.2 million people who are now jobless.

In any case, Nomura’s Charlie McElligott notes that markets were braced for this.

“With whispers pushing towards 5mm+ on a ‘bottoms-up’… the actual reaction to the 3.2mm print was ‘bullish’ despite everybody knowing this is just the beginning of a horrific few months of data to come”, Charlie said, following the release.

When it comes to equities, US stocks were gunning for a third straight day of gains Thursday, and through mid-morning stateside, the Dow had risen a truly hilarious 18% since the cash open Tuesday.

There is, of course, more to this than “stimulus optimism”. As McElligott reiterates, “stocks [are] holding the line for the various flow reasons we’ve spoken-about over the past week”.

By that, he means the dealer gamma drop-off post expiry, vol.-control having nothing left to sell (see the updated chart) and CTAs now covering and flipping “incrementally long” in the Nasdaq, on Nomura’s model.

For those curious, the risk parity visual below shows the breakdown (by asset) of the epic deleveraging that unfolded over the course of the rout.

The following chart is based on Nomura’s QIS model, and you should note that the estimated weights shown with the teal pentagons (18.9% for stocks, 101.8% for bonds, 83.3% for credit and 31.6% for commodities) rank in the 0.3%ile, 0.3%ile, 0.1%ile, and 13%ile going back to 2011.

Given this massive exposure “gashing” into a truly historic VaR shock, there’s not much left when it comes to de-leveraging. So, vol.-control and risk parity (as well as CTAs) are more likely to be “buyers” from here, contingent, obviously, on the world not ending and some horrific/macabre outcome on the virus front not forcing volatility into the stratosphere again.

And don’t forget about the rebalancing flow which Charlie reminds you is “on account of epic ‘bond over stock’ outperformance QTD”.

Read more: A $900 Billion Rebalancing Flow?

Beyond all of that, McElligott reiterates that we’re witnessing the monetization of upside volatility trades via the VIX ETN/ETF complex. That, as noted here, is causing what he characterizes as “monster selling in UX on aggregate, especially after the peak of the short gamma stop-outs in vol last week”.

Any sustained move lower in vol. will eventually pull back in the vol.-targeting universe, whose re-leveraging would come on top of rebalancing flows and “first mover” CTA trend re-risking. Or at least that’s the “constructive” take.

And what of hedging flows in this (hopefully) more benign, post-OpEx environment?

Well, as Charlie writes, “we are finally seeing the return of overwriters in the equities vol space, which day-by-passing-day of incremental price stability will eventually tilt the dealer gamma profile back towards ‘long’ [helping] insulate the market from large swings in either direction, as their hedging flows tend to buy weakness/sell strength”.