Nomura’s McElligott On October As The Anti-Status Quo And The ‘New’ Election Tail Risk

October’s action in rates and associated thematic expressions in equities represent a “reversal” of the decade-old “status quo,” Nomura’s Charlie McElligott wrote Friday.

As the market continues to buy into the Democratic sweep narrative, trades associated with a more reflationary macro backdrop are gathering momentum.

This is quite ironic. As discussed here on Thursday evening, the last time we saw the 5s30s this steep was in the immediate aftermath of Donald Trump’s 2016 victory. The Russell 2000’s monthly outperformance versus the Nasdaq 100 is among the largest since November 2016, when similar expectations of fiscal stimulus boosted small-caps.

“The multi-year ‘everything duration’ thematic within Equities performance and consensual positioning [has] wobbled, as perpetual ‘Cyclical Value’ laggards outperformed the near decade-long dominance of ‘Secular Growth’ and ‘Min Vol,’ as it’s the same ‘bond proxy’,” McElligott went on to say.

He also talked a bit about Thursday’s price action, noting that “options were a huge part of the story [as] the owner of [a] lumpy SPX 3425 / 3525 put spread from back on 10/13 and expiring Friday was anticipated to be in the market.” He provided some granular context that fans will appreciate. To wit, from Charlie:

With so much Gamma this close to expiry and sitting right at the bottom strike (with spot ~3430 at the time was like ~$4.7B delta adjusted notional and $2B of Gamma), this meant dealers who were LONG the in-play option (buying $2B per 1% move lower or selling $2B per 1% move higher) were largely keeping S&P future pinned right around 3425 for the majority of the morning and midday–HOWEVER and as expected with this market player (who typically does not hold to expiration)…early in the afternoon, they began offering partial of the position OUT LOUD on the floor (selling at least 3k), which then created large billion-ish dollars of Spooz to buy–and helping S&P close nears highs of the day.

Not for nothin’ but you’re reminded that the extra index liquidity typically available during the final half-hour of trading no longer exists, at least on a simple market depth metric.

In any event, panning back out, McElligott notes that “more people” are starting to come around to the idea that the election outcome will be “much cleaner” than feared. You might recall that Charlie has variously suggested that in the event the result is known quickly and the scope for contestation is limited, the rapid unwinding of hedges as they decay into expiry represents a “right-tail risk” that could “slingshot” stocks higher, even as it would compete in a Biden win with cash selling associated with presumed de-rating tied to expected corporate tax hikes.

Discussing that scenario (the “slingshot” dynamic) on Friday, Charlie said “a lot of folks [are] pushing these VIX 1×2 Put Spreads trading in the market, looking to put this on as their ‘short vol’ trade expression to capture a [year-end] melt-up.”

Meanwhile, thanks to the relatively quick recovery and “calm-down” (if you will) from September’s tech-inspired mini-correction, one-month realized has now retreated, which has implications for the vol-control universe. When one-month leapfrogged three-month, it set up potential problems, as the “background,” mechanical bid from vol-control risked becoming a drag (i.e., de-leveraging). Here’s where things stand now:

“Now, we see 3-month realized as the new trigger input as it is the max of the two lookback windows,” McElligott remarked Friday, noting that “this has meant a recent blast of BUYING per the VC model over five of the past six sessions… helping stabilize [the] market against headline shock potential.”

So, what’s the takeaway on Friday? Well, simple: With consensus now coalescing around i) a Democratic sweep, ii) the read-through of that outcome for fiscal stimulus, and iii) the prospect of a “clean” election that delivers a winner relatively quickly, it may be time to be a bit cautious at the margins.

Remember, the Senate matters. If Biden prevails but the Senate doesn’t flip, then getting a large stimulus deal through Congress will remain a kind of Sisyphean task for House Democrats and The White House, akin to what we’ve seen over the past two weeks as Nancy Pelosi, Steve Mnuchin, and Trump roll the stone up the hill only for Mitch McConnell to say something that effectively rolls it back down.

“This is why flattening expressions need to be looked at as hedges,” McElligott said. “Because everybody is set-up for the bear-steepening / pro-cyclical fiscal stimulus + deficit spend + infrastructure + vaccine RECOVERY trade.”

Read more:

Why The Size Of A Senate Majority Is ‘More Important Than Ever’ And The Fate Of The Filibuster

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8 thoughts on “Nomura’s McElligott On October As The Anti-Status Quo And The ‘New’ Election Tail Risk

  1. I have seen no discussion for potential tax/regulatory management selling end of year. Case is Biden may increase taxes for those making more than $400k and gains this year could evaporate next year under supposed new regulatory regime. Closing two risks could be attractive to at least some.

    1. I wish I had the problem of worrying about my taxes going up because my household has an income that exceeds $400k per year. There are about 1.8B households in the world. Median (not mean), the median income is about $10,000 per year worldwide. $400k is like 35 standard deviations in a flawed model that uses Gaussian distribution. In the US, median household income is about $65k. $400k is about the 1% threshold.

      Households with $400k income per year are never going to be the Koch’s. They should put the tape measure away.

      1. My wife died on New Year’s Eve in 2019 and this year, under Trump’s tax law, my applicable bracket will rise two notches because of my reversion to single taxpayer status. Between that and my monster medical insurance costs (Medicare alone is $5500/year) I don’t need Biden when I got the Donald. Boy, do I need his legal and accounting team.

        1. An aside: 62yo single self-employed with a standard BCBS health plan that I pay $21,000 for (prem + deductible)
          I can’t wait to pay a monster $5500/yr for Medicare. Even with the other parts, I’ll be saving nice money once it kicks in.
          Our healthcare/insurance system is a mess

          Sorry to hear about your wife.

  2. “The Russell 2000’s monthly outperformance versus the Nasdaq 100 is among the largest since November 2016, when similar expectations of fiscal stimulus boosted small-caps.”

    Don’t forget a large part of the narrative was that small caps were more “inward-facing” so they would be better placed as Trump rolled out his aggressive trade policies.

  3. I think a lot of H’s strategist and his editing of it is great. But their time horizon is relatively short. I manage money for folks and there is only a bit of a lean in using these points from time to time. It is not great to react to the market on a 1 week to 90 day horizon. The unsaid read through on a lot of the stimulus is that it takes a long time for it to get there. February looks like a reasonable guess. You also must ask yourself why such stimulus is necessary? It is because there are tremendous deflationary headwinds out there. The upshot of this is that much of the stimulus spending thus far is to keep the wolf from the door. Was it necessary? Absolutely. But the end result will be slower growth afterwards as much of the stimulus is to be spent, not invested in productive assets. Until some of the big issues are adressed such as a tattered safety net, bad infrastructure, underinvestment in public goods such as health and education, and grossly bad income and wealth distribution we can expect subpar economic performance. I believe we can right the ship but it is going to take several years and we are facing a harsh fall and winter economically first.

      1. Assuming Democrat controlled Senate: passing stimulus will require abandonment of the filibuster, right? Do we assume that is a done deal?

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