Markets stocks VIX volatility

Nomura’s Charlie McElligott Explains Why Stocks Rallied In Face Of Depression

These are modern markets. You must learn to speak the language.

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.


10 comments on “Nomura’s Charlie McElligott Explains Why Stocks Rallied In Face Of Depression

  1. Beautiful summary H; as someone who learns a bit of the language before he travels anywhere, that connected with me.

    Is the sandwich long equities and the Coke a hedge? How far can we stretch this metaphor?

  2. Sadly, the leveraged specs will have more impact now that share buy-back activity is being ratcheted back. That has been the overwhelmingly largest bid in the market for eight plus years.

    Ah well, anyone else here remember when capital markets were venues where providers of capital funded entrepreneurs and existing businesses?? Back then the financial sector was an intermediary and did not represent the kind of share of GDP it does now. Since 1976, I’ve watched the transformation of financial markets from a funding mechanism into playgrounds for speculators.

    But, as our Dear Leader rightly reminds us, there is no point to grousing about it. It’s the reality.

    • Oh, the irony of Mitt Romney grousing about “takers” in a room full of private equity dudes.

  3. The rapid increase in the equity markets is (lucky for issuers) a perfect backdrop for debt offerings and some add-on equity offerings. We will see.

  4. Brings back a memory which has really stuck with me. In the 70s I was a wild-ass speculator in metals and ag markets. But i could see that old school “seat of the pants” traders were going to be pushed aside by more sophisticated model and math-driven actors so I went to business school and learned about options and such.

    After I finished up I returned to Wall Street and resumed my career as a financial parasite. At the time my father questioned me. “Why do you want to work in a field that produces nothing of value? Why not look to work at a manufacturer that actually produces things?”

    Needless to say I brushed his advice aside because spec trading was too much fun. But his question has become increasingly relevant in recent years.

    I wonder if the backlash against this will gain more of a footing as populists take over both political parties?

  5. Thanks for the summary. It helps make the financial gyrations make sense. Smart companies are making sure they have the capital structure sufficient to make it to the other side. We should see a pick up in long term borrowing and net equity issuance.

  6. I’m a bit sad we bid good bye to negative gamma (for now at least) it provided great options trading opportunities for a few weeks. The prevalence of systemic strategies and option hedging in modern markets, which H details so well on these pages, is the main reason I dismiss most commentary about investor sentiment in financial media, emotionless machines control the gyrations of our markets, just as surely as one day they will rule the Earth.

  7. I will be much happier than to learn Coke in a foreign language. I would love to find a book or article to step me through the fundamentals of this analysis. Please suggest, ANYONE, book titles or other educational material.

  8. Great post Dr H. After all this talk about “gamma” from you, it is finally sinking in through my thick skull what the heck you have been rattling on about.

  9. 2B of gamma in the graph around this level looks almost flat compared to where it was at in Feb. I think some of this melt up is CTAs and thin liquidity. A huge chunk of the run, maybe 40% is overnight index futures, just following nikkei and dax. We get some follow-through fomo in cash markets, but you are not seeing the massive jump in the last 5/10 minutes from dealer delta/gamma hedging you saw from oct 19-feb20. Of course if CTAs flip long as McG and others thing at 2900-2925 then we could see a real positive gamma build.

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