‘Perfect Storm’: McElligott On Tech Selloff, ARK ‘Feedback Loop’

A decade (plus) of what may as well have been one-way price action in tech and secular growth shares may be on the brink of a reckoning as the inflation zeitgeist tightens its grip.

That’s the message the market appeared to be sending early this week, as the Nasdaq melted and global tech shares plunged in sympathy amid surging inflation expectations and palpable concerns that policymakers may find themselves behind the curve in relatively short order.

Nomura’s Charlie McElligott called it “the old ‘perfect storm’ scenario” for a “meltdown” in tech and secular growth.

For more than a decade, a macro regime shift from “duration to reflation” has been waiting in the wings. Now, it may be “approach[ing] escape velocity,” McElligott wrote, in a Tuesday note.

He cited this week’s slate of inflation data stateside as the proximate cause for “bad inflation paranoia,” and noted another hot read on factory gate prices in China, where PPI jumped to the highest since October of 2017 on base effects and higher commodity prices (figure below).

All of this is colliding with bottlenecks and other supply chain disruptions to create “serious angst” around a “building impulse for the next selloff in rates and breakout in yields,” McElligott remarked.

That’s the macro backdrop. But, as ever, there are accelerants, one of which comes from what Charlie aptly described as the “negative feedback loop of the mega-high growth / high multiple / ‘unprofitable’ single-names within the monstrous ~$20B ARKK active ETF getting absolutely torched in recent weeks.”

Cathie Wood’s flagship, he suggested, is “itself acting [as] ‘shadow leverage,’ pressuring the selloff.” Like the Hang Seng Tech index, ARKK is down 30% from the highs. On Monday, 53 of its 58 holdings dropped.

McElligott noted the vehicle’s strategy of deploying “heavily concentrated positioning into… extraordinarily illiquid names,” a risk management practice one could plausibly compare to Archegos and Bill Hwang who, incidentally, seeded four ARK funds, according to Wood.

In addition to the concentrated nature of the bets, some of the names are inherently and “extremely” sensitive to rates, McElligott went on to say Tuesday, noting that “this has made ARKK a popular downside play/hedge in the options space, with Dealers essentially max ‘short Gamma’ near this current $98-100 level, while net Delta across options is ~ $-2B.”

And it gets worse (for tech, I mean).

Dealer positioning in QQQ currently means directional moves have the potential to be exacerbated by hedging flows. Charlie flagged an “extremely negative $Gamma reading” that ranks in just the 1.5%ile, and an “explosion” lower in net Delta.

Finally, completing this not-so-virtuous circle, Nomura’s QIS CTA model suggested deleveraging in tech on Monday into the move lower after a sell trigger was hit on the 3-month window, flipping it short, along with the two-week and one-month windows.

“Overall [that] turned the multi-year legacy ‘+100% Long’ signal across all horizons down to just ‘+4.1% Long,’ implying ~$10.7B of notional selling in NQ futs in the deleveraging,” McElligott said.

Toss in evidence of hedge funds and asset managers selling and shorting alongside vol control shedding $2.6 billion in US equities to kick off the week, and it’s not difficult to see where things went wrong.

Obviously, jitters persisted into Tuesday even as the Nasdaq managed to claw back steep losses. While the April payrolls disappointment was supposed to calm nerves as it ostensibly presaged a longer runway for the taper discussion (and thereby rangebound rates and a supportive backdrop for growth shares), it’s possible it made things worse to the extent market participants are now concerned about labor shortages, what’s causing them and what the implications are for wage growth and thereby inflation.