“Guys I wouldn’t want to be in the past 24 hours? Outside of me thinking there was a ‘window for a pullback’ in stocks out of Op-Ex”, Nomura’s Charlie McElligott jokes, employing a bit of self-deprecating humor vis-à-vis his call for a move lower in equities this week.
It’s only Tuesday. There’s plenty of time for that call to play out. Indeed, Peter Navarro almost sealed the deal late Monday evening with a series of extremely inflammatory remarks about China, including his already infamous declaration that the trade deal is “over”.
Peter is the other guy McElligott says he wouldn’t want to be today. After all, Navarro’s “awkward truthiness” (as Charlie calls it) on the trade agreement and particularly the effect it briefly had on markets wasn’t a great digestif for a president who’d likely just finished a well-done NY strip (with ketchup) at the White House.
McElligott goes on to note that post-Op-Ex, S&P futures “have indeed been ‘unshackled’ to start this current week, free to move in a wider distribution/range as Dealer Gamma hedging needs dropped precipitously”.
The problem, he writes, is that “instead of what I saw as potential for a break lower in index futures into our noted 1w-2w ‘window for a pullback’… we have instead jolted powerfully higher, with my ego and PNL in the fetal position”.
Again, McElligott is probably being a bit too hard on himself. We hadn’t even made it to the Tuesday cash open by the time he penned those lines, but I suppose humility is always refreshing — I certainly never display any.
So, what accounts for the lack of a short-term pullback so far post-expiry? Well, lagged mechanical re-leveraging from the vol-control universe, McElligott says.
You’ll recall that vol-control simply purged down to nothing during the rout, and exposure in this universe is almost always an “escalator up/elevator down” dynamic. Vol-control has been slowly adding back exposure, and as Charlie writes on Tuesday, this has been the “one very significant source of incremental demand to buy US Equities futures, which is ‘real-time’ accelerating purchases in the market (particularly Monday)”.
The key here appears to be the dropping out of the worst days from the three-month lookback in Nomura’s model. Here’s a bit of color from the note to explain:
However, look at this snapshot below of “drop-off” days (NOTE: this is from Tuesday 6/16 last week to show “where” the impulse has come from over the past week and into the 3w ahead) which captures the significant number of “clustered” outlier realized volatility “shock” days in the 3m lookback window which soon would be dropping out of sample over the course of last week and into the coming weeks (e.g. -10.4%, -3.4%, -4.2%, -3.0%, -3.2%, -1.6%, -4.7% days all moving out of scope).
The overarching point is that the rolling off of those days from the three-month sample created a demand flow on the order of +$12.5 billion of SPX futures over the past week,+$28.1 billion over the past two weeks and, to quote directly, “most acutely a +$7.5 billion (91st %ile) BUY IMPULSE yesterday alone”.
In contrast to the visual I’ve used in these pages before (which shows the estimated notionals), McElligott says “the real point” for now is “the simple directional ‘impulse’ of buying from this rules-based section of the universe”.
This matters more than it might otherwise, McElligott says, for a simple reason. Namely that mechanical re-leveraging (i.e., this incremental buy flow) is unfolding against a backdrop where folks continue to exhibit signs of wanting to hedge/fade the rally. So, it’s created a kind of “daisy chain” dynamic, as McElligott puts it.
“It has painfully occurred in conjunction with meaningful selling in US Eq futures over the last 1-week reporting period, indicating potential ‘fodder for a squeeze’ or chase-back into flow”, Charlie writes, noting that “Asset Managers were meaningful sellers of a lumpy part of their US Eq futs longs [while] Leveraged Funds again added to short hedges” with overall net positioning for the latter in S&P futures now in the 0th %ile since 2006.
The bottom line, from where McElligott is sitting anyway, is the following:
… we might have triggered a “buyers are higher” dynamic, with the aforementioned 1) mechanical impulse of Vol Control buying coming off of 2) the “Gamma Unclenching” backdrop allowing for binary movement ($Gamma at 3200 now $1.644B, $Gamma at 3000 now $1.645B), all potentially forcing fundamental investors who, per futures data, were either still pressing shorts or profit-taking in longs and then hoping to / looking to “buy the dip” ahead of earnings thereafter now instead likely having to chase higher.
Until Peter Navarro’s next TV cameo, anyway.