You can thank, in part anyway, the virtuous volatility compression feedback loop for US equities’ resilience last week in the face of — and I’m still having a difficult time wrapping my head around this each time I write it — the first armed insurrection against the US government in 160 years.
“Equities options positioning shows the recent Dealer ‘long Gamma’ vs spot and incredibly supportive Vanna flows allowed SPX to stay sticky and even grind to fresh all-time highs last week,” Nomura’s Charlie McElligott wrote Monday.
Importantly, it wasn’t just the melee on Capitol Hill that equities had to contend with. The results of the Georgia runoffs prompted a sharp rise in US yields. While there’s most assuredly a bullish case to make for stocks around the prospect of a stronger and more sustainable fiscal impulse under Democrats, there’s a “mechanical problem” (if you will) with equities trading at dot-com multiples and a rapid backup in yields.
Everything is priced off record-low risk-free rates. If yields rise too far, too fast, it won’t matter that the absolute level is still very low historically. What will matter is that if, for example, 10s were to selloff all the way to ~1.25% in the next couple of weeks, we’d have seen a roughly two-standard deviation rise in the short space of a month. It’s very difficult (for me anyway) to imagine how equities can stomach that.
For his part, McElligott on Monday looked below the index level to flag demand for right tail exposure in sectors that would benefit from a pro-cyclical rotation.
He’d say “demand” is an inadequate adjective when it comes to capturing the mood. In his words, “‘right tail’ in those deepest of ‘Cyclical Value’ plays are at full-blown mongo ‘foaming at the mouth’ / ‘panic exposure grab’ levels.”
Basically, folks want exposure in the event these perennial laggards from the “slow-flation” macro environment that’s dominated for a decade suddenly decide to go parabolic over the next few months on stimulus optimism and a kind of “brighter days” re-opening zeitgeist predicated on vaccine rollout.
However, the flipside to this is that bigger deficit spending spurred on not just by a Democratic Congress, but also by a Treasury Secretary who I continue to believe will wield considerably more sway than any in recent memory, combined with a Fed that’s keen to engineer inflation overshoots, raises the risk of a cross-asset volatility shock down the road in the event some kind of vicious, destabilizing bear-steepener comes calling.
McElligott said a bid for longer-dated index downside is tied directly to that risk.
“This would be when the feel good of ‘reflation’ turns into concerns of ‘too much, too soon’,” he wrote, reiterating points from last week about the extent to which such a scenario would become “a complication for the Fed,” perhaps forcing market participants to pull forward normalization, with predictable results for real rates, the dollar, stocks, and vol.
Apropos, he noted that while clients are currently pressing the issue when it comes to trades that benefit from a continuation of the bond selloff, there’s also demand from tail hedge funds “for longer expiry (1Y, 2Y, 3Y) ‘bear flattener’ expressions.”
In other words: Some folks out there want protection in the event rate hikes commence sooner than the currently expected liftoff date of “never.”
I get the angst and the logic but, still… You get the impression, to quote I can’t remember who parodying Friedman, that “inflation is always and everywhere just around the corner”… i.e. couldn’t we wait for at least a tiny bit of proof that fiscally powered demand would overwhelm the economic slack presently in the system before rushing to declare inflation about to jump out of the box?
I want Mr. Market to think like that too, but Mr. Market often disappoints in that regard.
Why do we need to wait for proof of fiscally powered demand? What about CB-driven dollar devaluation? Here in NYC, the missus and I pay $44 — $50 w. tip — for a 12-inch pizza round and a nice chopped salad (for two).
Foodstuff is notably volatile. It’s not that it doesn’t count, it’s just not in the core CPI.
We can argue all day long about inflation measurements and hedonic adjustments and owners’ equivalent rent or indeed the impact of Tech on free goods.
I don’t mind updating the calculations and I think it’s important to note that a cheap TV or a cheap car doesn’t compensate for higher ed costs or higher health care costs BUT, on average, you cannot say that inflation, as standardly measured, is rising fast in the developed world.
H – Aren’t you giving them too much credit? “… the first armed insurrection against the US government in 160 years.” That scene struck me more as a few hundred drifters, losers, and pretenders amped up on Mountain Dew and Marlboro Reds acting as complete jackasses with nefarious, but spontaneous, idiotic actions. Perhaps I am downplaying it, but “armed insurrection” implies some level of professionalism, planning, discipline, etc. That’s about as far from that group as can be. Homer Simpson would have qualified as a leader in that crowd.
I think that all of the attention actually inspires such idiots to try more shit. In my humble opinion, words such as insurrection, coup, and rebellion (which others have used), lend credence and credibility to what was a disorganized group of misfits stirring up trouble. I envision a scenario similar to the end of Animal House when Bluto was rallying the fraternity to terrorize the parade. The whole thing probably came together at the Dunkin just off the Mall over black coffee and cake donuts. Losers.
Sean- wish I could believe you are correct about the lack of professionalism at the Capitol last week. Yes, many there were acting as you describe. But it would have taken only one pro, and I believe there were more than one in the mix, to kill several members of the House or Senate that day. The VP was at subject to the same level of serious risk. Fortunately, and extremely so IMHO, the targets of the pros were scrambled to safety.
I cannot imagine anyone downplaying the mob, and some of its member’s intentions, unless they were, at some level, ok with some of what went down. A quick read of numerous articles indicating coordinated efforts should be enough to dissuade your Dunkin comments. Just saying. I do agree with your losers comment.
longinTTH: Fair enough. And for the record, I am 100% NOT OK with what went on. Perhaps I should have dug deeper as I did not see articles that detailed the level of planning. The whole event struck me as impulsive amateur hour.
Sean- glad to hear you’re not ok with the Capitol events. I don’t normally post but this issue has too much weight for our country in my view. At this point with Trump as President, and apparently many who take his word as almost gospel, I think more of us who might have stayed silent so far should start speaking up. He is more than a clown and extremely dangerous IMHO, with a fervent following.
insurection
NOUN
A violent uprising against an authority or government.
It could have been much worse. That makes it no less an insurrection. These idiots for the moment think that they are getting tickets for being in the park after dark. The prosecutorial powers are not nearly up to speed yet. Great job being done by the armchair sleuths.
Indeed, a trained dedicated team as small as 5-10 could have killed any and all political opposition in one fell swoop and the events demonstrated exactly how to run interference for such a coup in the future. If decisive action isn’t taken then we’re begging for another attempt next time we get an authoritarian in the presidency and I doubt you will have to wait long and I suspect next time that dedicated team will be a privately contracted PMC.
Not to mention we’re already hearing news of planned armed insurrections at the state level near inauguration day. This isn’t over yet.
He is a clown AND he is dangerous. Timothy McVeigh also mounted an attack on the government back in the 90s. The difference though is that he was part of a small cell. This terrorist cell was much bigger and was sourced and set loose by the President of the US against another branch of the government. It also appears Trump took some actions to thwart or inhibit law enforcement from putting down the insurrection. So while there were a lot of losers in the crowd there apparently were military, police, former military (she ended up losing her life), and members of state legislatures there. They are anything but amateurs. The proud boys and other far right groups were there too. And there was no shortage of other white supremicists. To top it off you had Senators and House leaders backing Trump. Josh Hawley gave the crowd the right fist in the air outside the Congress. All in all not a pretty picture.