Nomura’s Charlie McElligott is back from “spring break”, which he says simply entailed “stay-cationing” at the house, presumably due to virus lockdown protocol in the Tri-state area.
His first order of business is to document just how prescient his tactical trade from March 31 turned out to be.
Two weeks back, McElligott cautioned that April is the worst month for the “1Y Price Momentum” factor dating-back to 1984. “1Y Price Momentum” has, of course, been long secular growth and defensives and short value, cyclicals and high beta. It’s basically just the ultimate expression of long the vaunted “duration infatuation” and short a pro-cyclical rotation (i.e., short anything that would benefit from robust growth outcomes, higher inflation and a bear-steepener).
Well, fast forward to mid-April and the 1Y Price Momentum factor market-neutral is down more than 11%, while a “pain trade” proxy (so, value versus momentum) is up almost 27%.
“My ‘pain trade’ proxy looks at the relative performance of EBITDA/EV factor versus that of ‘1Y Price Momentum'”, he explains, before noting that the 27% return over eight days is almost a five standard deviation move.
Charlie observes that the scope of the rotation “puts this thematic reversal shock on par with that of prior performance blasts in October 2015, March 2016 and the tectonic September 2019 ‘Momentum Massacre'”.
Regular readers will remember that “tectonic” rotation from September. It came on the heels of an epic bond rally in August, when a plunge in yields initially catalyzed by growth worries from tariff escalations was turbocharged by convexity hedging and exacerbated by thin liquidity. That led to a downside overshoot (i.e., a bond rally that ran out ahead of itself), which reversed in dramatic fashion the following month. As yields spiked in early September, a variety of equity expressions tethered to the “duration infatuation” in rates were unwound. At the time, McElligott called it “one of the more stunning trades in modern market history”.
“Betting that the stock market’s losers will finally win has returned nearly 30% this week”, Bloomberg’s Luke Kawa observed last Thursday, headed into the long weekend. “[It’s been] the best week for the short momo leg since November 2008”, he added.
That outperformance came off a bit by the time the closing bell sounded on the best week for US equities since 1974, but momentum shorts still surged more than 23% during the holiday-crimped week, leading to outperformance of nearly 12% to the S&P.
(BBG)
So, what’s next? Or, as McElligott puts it: “Could this be ‘it’?” “It” refers to a definitive signal that the long-awaited value over growth rotation is finally here.
The short answer is as follows, from Charlie:
When looking at the scale and pace of the momentum reversal violence contingent to recently having made a multi-year high, “1Y Price Momentum” factor continues to struggle and frankly, get hammered, almost entirely on account of the “Mo Shorts” (i.e. Cyclical Beta / Value”) continuing to rally locally and outperform the “Mo Longs” over the next two months, before everything gets hit out ~3m / 6m in what could be a regime change or “rotation,” potentially tied to a US economic recession in this case (which may in-fact be the Value over Growth signal, as UNPRECEDENTED fiscal- and monetary- stimulus “hits”).
Looking at historical instances of momentum shorts staging a 99.8%ile one-week return after having recently hit a multi-year nadir, the picture isn’t pretty for the broader market in the medium-term, although things improve thereafter.
Specifically, McElligott notes that in cases like that (i.e., momentum shorts ripping in statistically anomalous fashion from multi-year lows), the S&P has fallen a median 17.3% over the subsequent three months, before surging thereafter.
I would simply reiterate that headed into 2020, the general market narrative centered around an assumption that the nascent pro-cyclical rotation catalyzed by trade optimism and the lagged effect of 2019’s rate cuts would continue, and accelerate.
McElligott was skeptical – not because he forecast a pandemic, obviously, but simply because he thought the narrative had overshot.
He was proven correct in dramatic fashion in January. The pro-cyclical rotation many market participants came into the year betting on (or, at the least, hoping for) didn’t pan out. It’s worth noting that many trades tethered to that thesis were already underperforming prior to COVID-19 “going global”, so to speak.
The bottom line now is that if you can somehow look past the epidemic and the inevitable economic carnage it will leave in its wake (not to mention the tragic human suffering), it’s at least worth considering that Trump has “green-lighted advocacy of a debt-binge financed ‘New Deal 2.0′”, as McElligott put it in the March 31 note mentioned above.
Just four months ago, many market participants were convinced that the pro-cyclical rotation was upon us and would be sticking around for the foreseeable future.
By March, the world was ablaze, demand destruction was in full effect and it looked, briefly, like 10-year yields in the US might hit zero. Being bullish anything that would benefit from robust growth outcomes, higher inflation and a bear-steepener seemed ludicrous.
Now, here we are two weeks into April staring at an epic reversal on the back of extreme policy panic (both fiscal and monetary) and a historic OPEC+ deal (“too little, too late” criticism of the pact aside).
So, as the famous quote from Indiana Jones and the Last Crusade goes: “You must choose. But choose wisely.”
I struggle with this writing. Is there a book or resource that explains the jargon?