Nomura’s Charlie McElligott On The Rally And The Future Of Macro

"...we would need to see an unprecedented marriage where both monetary and fiscal policy align in a magnitude not previously experienced".

Growing consternation about the state of Sino-US relations notwithstanding, equities are remarkably resilient.

US stocks have held onto the majority of the dramatic ~30% bounce off the March nadir, even as the data betrays the depth of the recession and headlines about a “second wave” of the virus are a fixture on the nightly news.

Although Wednesday may be blighted by ongoing escalations with China, four of the past five sessions have been strong indeed.

On Thursday, Nomura’s Charlie McElligott is out with a lengthy note which has a “lay of the land” feel to it.

When it comes to strength in US equities, Charlie flags three contributing factors. First is systematic flows.

“After recently dictating partial covering in prior legacy shorts across many global Equities futures, yesterday’s CTA Trend model outright ‘flipped’ from the prior -53% Short signal to a +100% Long one on the trade above 2964, generating an estimated +$17 billion of futures to buy”, he writes, before cautioning that “we remain near [a] ‘trigger’ level for more chop in the signal at 2959, which is teetering near spot”.


This matters, because as mechanical flows push us higher, carbon-based lifeforms are forced to react, and they’re offsides.

Reiterating points from earlier this week, Charlie again flags “widespread institutional investor under-positioning into the rally”.

(Nomura, CFTC)

Finally, McElligott describes the narrative shift. Charlie is pretty unique among those of a quant persuasion when it comes to his capacity to weigh in on qualitative, macro shifts and weave that discussion into the tale of the tape. That’s on full display in Thursday’s note.

“Investors are seemingly embracing the view that the ‘cure was worse than the disease'”, he says, adding that “as many areas are racing to reopen and economies stop the shock-down, sentiment then too pivots and recovers, particularly as data is showing that infection rates are actually declining in areas where lockdowns have been unwound”.

That may (or may not) be a reference to Marko Kolanovic’s widely-cited note from Wednesday, which caused quite a bit of discussion on social media, and apparently found its way onto at least one prime time news broadcast. Those interested can read my extensive take on Marko’s latest here, but the passage that generated the most discussion is this one:

While we often hear that lockdowns are driven by scientific models, and that there is an exact relationship between the level of economic activity and spread of virus – this is not supported by the data. Figure 2 below show virus spread rates before and after lockdown for different countries around the world, and Figure 1 shows the spread for US states that have re-opened. In particular, regression shows that infection rates declined, not increased, after lockdowns ended (for US states we show most recent R0 vs R0 on the day of lockdown end, and for countries we show infection rates). For example, the data in Figure 2 shows a decrease in infection rates after countries eased national lockdowns with >99% statistical significance. Indeed, virtually everywhere, infection rates have declined after reopening even after allowing for an appropriate measurement lag.

McElligott doesn’t get down into the weeds on that (which is probably for the better, as it’s a thorny discussion that doesn’t lend itself to polite discourse). Rather, he simply notes that when you throw in vaccine optimism, you end up with a rationale to support a constructive take on risk assets.

“[All of this] comes in conjunction with the constructive vaccine headlines and monetary/fiscal policy interventions as additional catalysts for the inflection away from ‘risk-off’ defensive positioning”, Charlie writes.

Obviously, the above doesn’t necessarily “play well” (if you will) with the “forever trade” which has been so pervasive in the post-crisis, “slow-flation” world. By that, I mean long equities expressions tethered to the “duration infatuation” in rates, and long secular growth, which of course is synonymous with being bullish on the tech titans that now comprise some 21% of the S&P.

In this context, news that Angela Merkel and Emmanuel Macron may (against all odds) succeed in convincing recalcitrant countries (a category which has, of course, included Germany) to back burden-sharing as part of a proposed €550 billion rescue fund, adds a potential bear-steepening catalyst that could accelerate and amplify everything noted above.

On this, McElligott offers quite a bit of color – and by that, I mean more than 1,000 words. Here are three short excerpts which capture the important points:

As I noted recently since the recent spate of “bear-steepening” began over the past month +, the vast majority had been driven by… duration-tilted “supply” coming from Treasury and Corps, in conjunction with the gradually shrinking Fed buybacks…BUT now that we are seeing some evidence of investor sentiment “green shoots” with regards to the potential of a globally reopened economy alongside unprecedented monetary- and fiscal- stimulus, the relative weakness in the long-end has generated so seemingly “stickier” performance reversal dynamics in the U.S. Equities space.

However and as stated for years now, it remains my view that in order to see a sustained, secular shift to a long-term “growth-ier” and more “reflationary” outlook and portfolio positioning (away from the current and complete investor skepticism towards inflation), we would need to see an unprecedented marriage where both monetary- and fiscal- policy align in a magnitude the likes of which we had never previously experienced.

Thus, CRITICALLY, the news this week on Merkel / Macron proposal signaling German willingness to mutualize debt for a special Coronavirus fund… is a potentially monumental first step in removing the European “fiscal shackle” which could further benefit this portfolio rotation, risking an further unwind of the legacy status-quo “Momentum” positioning in painful fashion for investors who have hidden in the bond proxies and shorted cyclicals for years now.

As he alludes to in those passages, this is a situation where only “seeing” will be “believing”, as it were.

It’s true that the pandemic has accelerated the world down the road to direct deficit financing. It’s also laid bare the absolute necessity of fiscal stimulus complimenting monetary policy, which is thoroughly exhausted after a decade of playing Atlas both to the global economy and, especially, vis-à-vis asset prices.

But this shift towards a true monetary-fiscal union across developed economies – i.e., a state of affairs that sees the marriage consummated by an outright admission that the former is enabling the latter, thus lifting the veil on something that’s remained a “dirty little secret” over the QE years – remains elusive for a number of reasons. The subject is considered taboo, and not just by the hard money types, but even by traditional, mainstream economists, who are averse to the notion of direct government financing and “helicopter money”.

Maybe COVID-19 has changed the game in that regard. We’ll see.


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