Gathering storm clouds notwithstanding, market participants are obliged to ponder the somewhat surreal prospect that, as apocalyptic as everything seemed in March, the pandemic plunge amounted to nothing more than a dip-buying opportunity.
Don’t misconstrue that as an attempt to downplay widespread economic suffering on Main Street. And certainly don’t take it as an effort to trivialize the tragedy inherent in the 668,000 lives lost so far in the pandemic.
Rather, the point is simply that from the perspective of someone willing to ignore the largest public health crisis in a century on the way to buying everything in sight in mid-March confident that central banks (and especially the Fed) would prop up asset prices, this was a simple trade.
“Hindsight being 20/20, could it really have been that simple on the 2020 version of the ‘Fed rides to the rescue’ trade yet again?”, Nomura’s Charlie McElligott asks, in a Thursday note. “The answer seems to be a resounding ‘YES'”, he goes on to say, referencing the returns shown in the figure (above).
If you’re among those who participated in the surge, you now have an opportunity to take profits ahead of a potentially volatile August (when illiquidity reigns) and into an election which promises all the drama you’d expect considering the demeanor of the incumbent.
“You had a lot of motivation to profit-take with this summer Fed meeting marking ‘sell the news’, especially when looking at the August historic seasonality for ‘vol events'”, McElligott goes on to say, noting that August has been “the single-best VIX 1m average net change over the past 15 years”.
Thursday morning brought another inauspicious jobless claims report, which hit concurrent with (predictably terrible) second quarter GDP data and just 16 minutes before Donald Trump floated the idea of delaying the election. At the same time, Republicans and Democrats are said to be “miles apart” on an agreement around the next virus relief package.
The next big test for US equities will be mega-cap tech earnings, which are set against Wednesday’s somewhat farcical CEO tele-hearings.
Remember, big-cap tech is Atlas for this market. It isn’t clear what happens in the event the companies which comprise 22% of the S&P’s market cap were to suddenly roll over at a time when the economy is showing signs of renewed weakness, undercutting the case for the pro-cyclical trades which might otherwise take the baton from tech.
“For US Equities, there is a critical test developing within multi-year regime leader ‘secular growth’ Nasdaq, which for the better part of a decade has continued to benefit from its ‘duration-sensitivity’ and bull-flattening in UST curves via a predominately ‘goldilocks’ US economy”, McElligott says, in the same Thursday note.
The perennial winners in secular growth and other equities expressions tethered to the duration infatuation in rates and the long-running “slow-flation” macro environment, are now “agitating under ‘crowding’ risk and the weight of both [their] own ‘perpetual growth’ expectations and valuations”, Charlie cautions, citing the explosion in factor volatility over the past several months.
Meanwhile, headed into earnings from the titans, McElligott writes that in QQQ options, dealers are “increasingly short Gamma, with Gamma vs spot ‘neutral’ level up at $261.90, or $262.11 ex 7/31/20 expiry”.
This means that moves to the downside could be exacerbated by hedging dynamics.
Going forward, the main question for me isn’t so much whether the five companies currently shouldering the burden of the broader market’s YTD gains can continue to expand their ubiquity (possibly drawing still more regulatory scrutiny, but that’s another issue). Rather, the question is what happens in the event their shares undergo a necessary de-rating due solely to being overextended.
As alluded to above, it seems likely that the macro environment in the US will be challenging over the next few months, which casts doubt on the notion that laggards like value, small-caps, and cyclicals can fill the void left by tech if the latter decides to take a well-deserved breather.
I suppose it doesn’t matter. We can all relax as long as the Fed is “absolutely committed to staying in this until we’re very confident that [accommodative monetary policy] is no longer needed”, to quote Jerome Powell.