Amid counterintuitive outperformance from perennial, “slow-flation” winners-turned reflation trade laggards, enquiring minds want to know: What happened to my rotation?
The data is confirmatory. PMIs are screeching tea kettles. The labor market is pretty clearly on the mend (a recent uptick in jobless claims notwithstanding). And CPI just printed the biggest MoM gain since 2012.
So, what’s wrong with the “boom” narrative? Where’s the flaw in the “summer bonanza” thesis?
Well, there’s probably nothing wrong with the narrative and no flaw in the thesis. Rather, as Nomura’s Charlie McElligott suggested earlier this week, it could just be that the easy money has been made, and now that we’re transitioning from rebound to expansion, the trade is more nuanced.
For example, the latest edition of BofA’s Global Fund Manager survey showed investors reverting to a tech-cyclicals barbell while paring EM and commodities. But there’s still broad-based agreement that the pro-cyclical themes (with value over growth being perhaps the most prominent) are intact.
Read more: Kolanovic Suggests Style ‘Turning Point.’ Investors Debate Rate ‘Reckoning’
In a Wednesday note, McElligott reiterated that so far in April “bond proxies and their ilk counterintuitively” drove MTD performance, with “Secular Growth, HF Crowding, Mega-Cap, Low Risk, Quality and Defensive Value all meaningfully outperforming the prior YTD leadership of Cyclical Value, Leverage, High Beta, Small Cap and Short Interest.”
Again, that’s despite the data ostensibly confirming the boom narrative. But it’s not totally counterintuitive if you look at rates. 10-year yields have gone nowhere recently.
That’s not to say the action in Treasurys is completely antithetical to the reflation narrative. Rather, it’s just to say that there’s a seeming dearth of conviction when it comes to any further backup in yields, and if CPI and this week’s supply weren’t enough to reignite or otherwise rekindle the bond selloff, then it’s not clear what will. Maybe retail sales. We’ll see. But for now, the bond “bear” (and I’m still hesitant to call it that) appears to be on pause, so bond proxies and other duration-sensitive equities expressions can attempt to regain some traction.
“The main question being asked [by] clients this week [is] ‘What will it take to reinvigorate the vaccine reflation + stimmy trade if we’ve already pulled-forward / priced-in the best of the transitory base effect in growth and particularly, inflation data?’,” McElligott went on to write Wednesday. His answer: “A re-acceleration in forward inflation expectations — particularly survey data — is likely required to kick-up animal spirits and rate vol / bear-steepening again.”
Bloomberg’s Laura Cooper weighed in on this. “So much for those inflation fears with Treasurys holding gains and demand for duration strong,” she wrote, noting that “a high bar for expectations meant price pressure hype didn’t match the market reaction and came alongside a stark reminder that vaccines (or lack thereof) still matter most.” That latter point was, of course, a reference to the J&J pause.
In the same Wednesday note, McElligott touched on right-tail risk, and the extent to which “crash-up” is suddenly en vogue. “The market zeitgeist shift from the prior ‘crash-down’ obsession [during] the first three months of the year pivoted hard to ‘fear of the RIGHT-tail’ by late March,” he wrote, adding that “accordingly, we have seen SPX Put Skew absolutely rinsed from prior upper 90%ile ranks to current 10-20-30th %ile, while SPX Call Skew has gone crazy-bid into 90s-100th %ile for near- to intermediate- dated stuff, which only a few months ago was lingering in the teens / 20s.”
That’s a key consideration. For those who may have missed it, you can read more in “MRA’s Curnutt Suggests Cure For Fund Manager ‘ROMO’.”
One of the points made in that linked article was that a reversal in apparent hedging interest via the VIX ETNs was a factor that may be helping to ease tension in the vol complex. McElligott hit on that too, noting that “the aggregate VIX ETN Net Vega position has decreased by nearly $85mm from the earlier YTD highs as prior long-vol hedges were reduced or monetized, allowing iVol to further soften from the ‘sticky higher’ levels experienced the first few months of the year.”
As for realized vol, the move back lower (figure below) has catalyzed re-leveraging from the vol control universe to the tune of some $27 billion over the past month, on Nomura’s model.
If equities can remain well-behaved, the “background” bid from vol control could continue.
Speaking of well-behaved, the distribution of outcomes very often depends on the strength of the vaunted gamma “pin.” On that score, McElligott wrote that his analytics suggest “~36% of SPX Gamma will be running-off after this Friday’s expiration, with an even more eye-watering 55% reduction of QQQ Gamma, 64% (!) of IWM and 47% of EEM.”
That, he cautioned, “sets us up for ‘freedom to move around the cabin’ thereafter beginning Friday morning and into start of next week, with the prior hedging buffers sharply lowered in both directions.”
