Nomura’s McElligott: Shorts ‘Mangled’ In ‘Risk-On Panic’

It’s “another violent extension of risk-on”, Nomura’s Charlie McElligott wrote Tuesday, as US equities surged on fresh stimulus hopes and blockbuster May retail sales data stateside.

This is all “contributing to that ‘pro-cyclical’ feel”, McElligott says, adding that market participants could be in for another round of outperformance from cyclical value and unwind-y (to hijack Charlie’s cadence) action in momentum factors.

Last week’s richening in government bonds looks to be in jeopardy as long-end yields cheapen globally and curves steepen anew in what McElligott calls “another manic swing (now higher) in growth- and inflation- expectations”.

Read more: A ‘Terrific Explosion’ (Or, Stimulus > Geopolitics)

Remember, we’re coming off the worst week for US equities since the March panic, and the action was characterized by a pause in the rotation trade that defined the previous three weeks. Also taking a breather was the steepener.

Now, we’re staring at a possible reinvigoration of that dynamic, and you can expect to see it reflected in cyclical value and high beta, at least on Tuesday, barring some kind of dramatic, left field turn for the worse.

McElligott coins a new phrase (or, maybe he’s used it before and I just missed it). To wit, from Charlie:

Worth reiterating on very back of envelope what the Fed is up to: $600B Main Street Lending program, $100B TALF, $750B PMCCF / SMCCF, $500B Muni Liquidity Facility has clients wanting to again “sell vol” into not just the traditional QE LSAP–but what I’d call LS(R)AP, a.k.a. Large Scale RISK Asset Purchases, as the clouds grow more opaque on what is considered “government-backed” these days.

That’s a reiteration of warnings from the moral hazard crowd, but you’ll note that instead of couching it in cautionary terms (i.e., instead of trying to weigh in on the normative side of things), McElligott simply describes what’s going on and pivots immediately to how it should be viewed in the context of tactical trades and long-term macro trends. That’s the proper way to go about things.

For those who need an illustration, the figure below shows you the Fed’s various emergency facilities.

It’s worth taking stock (figuratively and literally) of the remarkable turnaround in risk sentiment coming off a weekend that was defined by dour “second wave” headlines.

Following retail sales on Tuesday, S&P futures were +225 handles from the Monday overnight lows.

Commenting on Monday’s rather epic comeback (captured in the figure), McElligott notes that it “was again the vol space leading the move in the US session [as] we saw monetization of downside protection and/or grabbing into fresh upside expressions almost exclusively”.

Now, with the buy-side apparently grabbing for upside exposure (at this point, you can probably call it “grasping at straws” given how light positioning has been over the course of the rebound from the March panic), the read-through is that dealers are “comfortably” in long gamma territory, Charlie goes on to say. That means we’re pretty far removed from the dreaded “flip” levels, below which selling begets more selling.

(Nomura)

Asset managers bought the dip last week, apparently, but leveraged funds didn’t, adding shorts instead. And, so, that’s just more dry kindling for the pain trade higher, with macro funds still underexposed to the rally.

(Nomura)

And yet, remember that all of this comes with an important sequencing caveat for the back-half of the month.

“Following Friday’s Serial/Quarterly options expiry, we continue to see potential for a ‘Gamma Unclenching’ over the following 1w-2w period with currently ~47% of the $Gamma set to run-off”, McElligott reminds you. Between that, a potential drying up of over-writer flows and buyback blackouts, there’s scope for things to get messy in the event some macro “shock-down” catalyst comes calling.