Nomura’s McElligott: New US-China Fight Could Be ‘Dreaded Macro Shock-Down Catalyst’

The prospect of renewed Sino-US tensions as the White House seeks retribution for the coronavirus could be “the dreaded ‘macro shock-down’ catalyst”, Nomura’s Charlie McElligott writes, in a short Friday note.

In addition to some disappointment around certain aspects of Amazon and Apple’s reports, “accelerant (sell) flows” have been triggered, he warns.

The timing leaves something to be desired. We were seemingly on the verge of settling back into a more benign regime with CTAs flipping long in the S&P and dealers’ gamma positioning pivoting back into the “safe” (i.e., long) zone, where hedging flows would act to dampen volatility.

Now, it’s all back up in the air, thanks in no small part to potential recriminatory behavior from Washington and Beijing.

Citing all of the above, McElligott notes that May began with Spooz off ~135 handles from Thursday’s overnight highs, “aided and abetted by the Amazon and Apple’s warnings [and] pulled-outlooks”.

Where does that leave us? The short answer is in a precarious spot (and you can take “spot” figuratively and literally there). We’re one bombastic tweet away from things taking a turn for the unfortunate.

Here’s McElligott with the longer, more granular answer:

The extent / velocity of the selloff in Spooz matters because 1) it has seen us trade back below the trigger level where the CTA position signal would yet-again pivot back “short” as the 84.6% loading in the 6m window would “flip” (a close below 2926 has signal to -69% short, while below 2805 goes back -100% short–albeit all on smaller gross $ exposure) while also critically (especially into weekly expiration), 2) this current spot ref ~2840 level is actually back (lower) to the “Gamma Neutral” level from yesterday’s typically insulating “Long Gamma” position for Dealers…but certainly now capable of slipping into outright “Short Gamma” on another surge lower.

That’s how quickly our benign backdrop could change thanks to the confluence of a possible clash between Trump and Xi over the origins of the coronavirus and pessimism in the names that “count”, so to speak.

When you think about Amazon and Apple, remember that MSFT, AAPL, AMZN, GOOGL, and FB now account for 20% of market cap. That’s the highest concentration in more than three decades for the largest five S&P stocks.

(Goldman)

We really – really – need for those names to hold up and avoid succumbing to any kind of negative interpretation of quarterly results.

The bottom line is that we’re teetering precariously around key CTA flip levels and, perhaps more importantly, straddling the gamma flip zone.

“[Watch for] a bleed deeper into ‘Short Gamma’ territory now that we are slightly below the ‘Gamma Neutral’ level at 2847”, McElligott said Friday morning, adding that “things get especially frisky into an approach of 2805”.

Remember, large swings (i.e., big intraday ranges and seemingly magnified directional moves) are almost always associated with shifts into short gamma territory for dealers, who end up selling into the selloff, exacerbating things.

(Nomura)

Oh, the irony, if that were to play out during the first few sessions in May, in conjunction with a re-escalation of China-US tensions.

Remember, it was on the evening of May 5, 2019, that Donald Trump broke the Buenos Aires trade truce with a single tweet.

Minutes later, McElligott sent out a client blast warning that depending on how things panned out, SPX/SPY consolidated gamma could flip negative beyond which dealer hedging could exacerbate moves or, as he put it at the time, things “could get sloppy”.

And indeed they did – “get sloppy”, that is. May 2019 ended up being the worst month of an otherwise stellar year for US equities.