Was That It?

Was that it?

Market participants will be asking themselves some version of that simple question in the new week, as equities look to rebound after an abrupt correction in world-beating US tech shares stoked fears of a deeper selloff.

For months, stocks scaled the wall of worry, shaking off bankruptcies, defaults, a small business apocalypse, a second COVID wave, the worst quarter for corporate earnings in living memory, an escalating culture war between the world’s two superpowers, and violent social unrest across nearly every major metropolitan area in the US, on the way to fresh record highs. The S&P is the most expensive in two decades.

If you believe a vaccine is a foregone conclusion and you doubt the narrative that says America is on the brink of spiraling into anarchy triggered by a contested election outcome, then it’s possible to argue that things aren’t as stretched as they appear — that equities aren’t as detached from “reality” as they seem. Rather, they’re just “pulling forward” a brighter future. Fingers crossed.

For their part, Goldman is more bullish on the growth outlook than consensus. The bank is also Overweight stocks on a three-month and 12-month horizon, and sees the S&P at 3,800 by next summer. “We still think there is potential for a broader pro-cyclical shift across and within assets in the rest of the year”, the bank’s cross-asset team said last week.

Needless to say, betting on a pro-cyclical rotation has been a frustrating experience. Indeed, many an unfortunate soul spent the last decade waiting on a durable shift, only to be habitually disappointed by the persistence of the “slow-flation” macro environment. Then, the pandemic seemingly drove a nail in the coffin of value investing, which was arguably already dead.

There is no more poignant visual than the figure (below) when it comes to encapsulating the entire market/macro zeitgeist. It’s ubiquitous by now, but it somehow doesn’t lose its capacity to wow the audience.

That’s what happens when the “perpetual motion machine” dynamic that was already pushing mega-cap tech shares inexorably higher collides with an epochal global health shock which made the same technology companies not just indispensable, but in fact synonymous with every facet of life, from getting groceries to conducting business, in a hyper-digitized world.

“Numerous, overlapping structural changes — Japanification of bond markets, peak demand for Oil, work from home/travel domestically — have been frustrating Value trades for the past several years”, JPMorgan’s John Normand said last week, before noting that “at least one of these dynamics (work from home/travel domestically ) could begin to reverse through mass vaccinations, in turn driving more durable rotations into less-loved equity sectors, commodities and related currencies”. I’ll say it again: Fingers crossed.

“In order to create any long-term paradigm/narrative shift, an escalation into a new world of fiscal stimulus is required in both the US and Europe — certainly not just the current piecemeal, stopgap offerings”, Nomura’s Charlie McElligott says.

“Cynical investors who have bought the long-term ‘Secular Disinflation’ viewpoint need something that looks a lot more like permanent UBI and large-scale infrastructure rebuilds (New Deal 2.0), both of which are tied to election outcomes, while too needing sustained and broad global credit-pumping”, Charlie went on to remark, describing the kind of reflationary “shock treatment” the market needs to snap out of a mindset that’s become deeply entrenched.

Along those lines, it’s worth noting that credit creation in China accelerated to the highest since March in August (figure below).

Those are all big picture issues, of course. The more immediate concern for market participants is whether the pullback in the Nasdaq 100 was sufficient when it comes to letting some steam out of the screeching tea kettle following an options-fueled mania in US tech.

“The correction in tech is still mainly being viewed as technical (and a buying opportunity) but is perhaps also a sign investors are at least starting to look elsewhere”, AxiCorp’s Stephen Innes said Saturday. “The long Tech trade has worked, but we all know how crowded it is”. We sure do.

“Long options positioning [was] at the core of the recent pullback”, Deutsche Bank’s Srineel Jalagani, Parag Thatte, and Binky Chadha wrote, in their latest asset allocation update, adding that “OCC data show robust increases in open long calls and open short puts across the board, but led by small retail traders [with] option sizes of < 10 contracts”.

A look at the put/call volume ratio for small traders shows a veritable plunge from April through the beginning of September. “Historically, corrections in the put-call ratio have tended to have sharp but short-lived market impacts”, Deutsche Bank goes on to say.

As is the case for most banks’ positioning indicators, Deutsche’s aggregate measure isn’t stretched, and sits in just the 15th percentile. Both systematic and discretionary positioning moved lower over the past week.

Of course, no analysis of the prevailing circumstances would be complete without mentioning the elephant in the room.

“Despite the normalization of the put-call ratio and moderating option gamma exposure, investors still have to contend with the upcoming macro event of the US Presidential elections”, Deutsche’s Chadha remarks, adding that “prospects for volatility enduring post-election day are high”.

While chatting with one seasoned trader over the weekend, I mentioned the distinct possibility of protracted social unrest and potentially destabilizing behavior from the current administration after election day. “The country is better than that”, he said, ever the optimist on humanity, if not always on markets.