Nomura’s Charlie McElligott knows many market participants are stunned right now.
And not just by the size of the bounce in equities off the March lows, but also by the apparent resilience of the rebound.
It’s just not “right”, some folks indignantly proclaim, railing against the apparent injustice of a Fed-engineered surge in assets that “should” be struggling mightily to catch a bid.
Instead, global stocks were close to logging their best month since 2009.
But this is no real “mystery”, McElligott reminds you, and while the Fed has played a crucial role, it’s not just Jerome Powell.
The rally comes “to the shock of many who ‘fundamentally’ remain focused on the obviously horrific economic ramifications of the COVID-19 shutdown”, Charlie writes, in a Thursday piece, before noting that most market participants are operating “without an appreciation of the ability [for] equities to ‘pull forward’ future inflections, on top of client positioning dynamics, vol.-dealer positioning, hedging realities and the ‘sling-shot’ that is a market structure built upon ‘negative gamma’, which creates [a] seemingly rolling ‘crash down, then crash up” cycle”.
Regular readers are acutely familiar with all of this. Indeed, it was just two days ago when McElligott recapped the dynamics. I talked about it at length in “CTAs Set To Flip Long In S&P As Vol Normalization Triggers ‘Second-Order Slingshot’“.
It’s all a function of vol. resetting lower and otherwise “normalizing” in a world where, to quote Charlie’s classic March 5 note (see here), everyone “operates under frameworks which allow for greater leverage deployment into trending markets, and conversely, dictate de-grossings into ‘VaR-events'”.
One way or another, we’re all momentum traders operating under the same VaR risk management regime. Volatility is everyone’s exposure toggle.
The “slingshot” occurs when vol. resets sustainably lower, dictating mechanical re-leveraging from the vol.-control universe. As equities push through key levels, CTAs are drawn back in, as momentum builds.
Nomura’s QIS CTA model flipped this week in S&P futures from a “-69% Short” signal to “+100% Long”. That, McElligott writes, made “a total of $36.8 billion to buy across US equity futures on the session [Wednesday]”.
At the same time, we’re now back into territory where dealer hedging should act to dampen volatility or, at the least, won’t exacerbate directional moves in the kind of hair-on-fire fashion seen during March.
“With the flip in aggregate SPX / SPY dealer positioning to what had been ‘short gamma’ to then a ‘neutral gamma’ and now increasingly outright ‘long gamma’… we see the benefits of ‘vol suppressing’ dealer hedging behavior with these grinding, less spastic market moves”, Charlie writes.
None of this is to downplay the significance of the unprecedented collapse in economic activity both in the US and abroad. And it’s certainly not aimed at trivializing the plight of those affected. Nor is it to suggest it’s necessarily a good idea to buy into a market that’s already run ~30% off the lows.
Rather, the point is simply that you cannot understand price action in modern markets without at least attempting to grasp the dynamics outlined above.
This is an ongoing theme in these pages – these are modern markets, and if you’re going to trade them (as opposed to just “invest” in them and sit there for four decades), it is imperative that you become some semblance of fluent in the language spoken by the likes of McElligott and Marko Kolanovic.
That doesn’t mean it’s your native tongue – just that you can order a sandwich and a Coke if you need to.