Should Have Bought The Dip

You should have bought the dip.

US equities turned positive for the week on Thursday, erasing Monday’s dramatic selloff, and snapping the longest streak without a 1% daily advance since early last year in the process (figure below).

Thursday’s gain for the S&P was the largest since July 20. The narrative was retrofitted for the price action. Earlier this week, stocks were “rattled by the prospect of a systemic meltdown in the world’s second-largest economy.” Fast forward a few days and Evergrande was “in the rear view,” to quote one media outlet’s daily wrap.

As far as Evergrande goes, not much actually changed since Monday. The company missed at least two loan payments, obfuscated in a filing related to an interest payment due on a yuan note and is, for all intents and purposes, in default. Chinese officials are prepping local governments for the firm’s “downfall,” Dow Jones reported.

So, it’s not “in the rear view.” And neither is China’s burgeoning economic slowdown. What’s “in the rear view” is the September FOMC and I think it’s fair to say at least some market participants were just happy to get it out of the way.

“Being clear like this is a big help, and it’s what the market needed right now,” Elaine Stokes, a PM at Loomis Sayles, told Bloomberg Television. “We had a tough week, we’ve been worried about what’s going on in China, Delta and growth,” she added. The Fed “told us that they feel really good about the economy.”

Although the outcome of the September meeting was mostly status quo, the hawkish tilt (at the margins) is now being pitched as a positive development because it purportedly reflected officials’ upbeat take on the domestic situation. Stokes’s remarks echoed that story, but frankly, I’m not convinced equity investors are thinking that hard about things. The Fed will be buying assets at least through summer of next year, and even if liftoff comes in Q4 of 2022, that’s still quite a way off. That’s what matters. The clarity is on the duration of accommodation, not on the economy. As Powell himself reiterated on Wednesday, nobody knows where the economy is going to be in two years.

In any case, it’s enough to say investors’ classical conditioning remains intact. If you see a pullback or a vol expansion, you generally have less than 24 hours to capitalize. And likely under 72 hours before the entire move in spot is recouped.

“We’ve spoken this week about the ‘conditioned per back-test’ appearance of ‘reflexive vol sellers’ in arresting the crescendoing US equities selloff,” Nomura’s Charlie McElligott said Thursday, while recapping the flows on Monday that helped set the stage for an eventual rebound.

Charlie also noted that during Wednesday’s rally, there was some buying interest in “ultra-rare equities upside vols, along with a few other new ‘bullish’ expressions.” Nevertheless, the vol space remains tense. Demand for downside is “extreme versus still pervasive skepticism towards broad equities upside,” he added.

Ironically, rates were a bigger story Thursday than equities. Wednesday’s post-FOMC flattening was partially unwound and there was some chatter of a “delayed taper tantrum.”

Read more: Bond Rout Inspires ‘Delayed Taper Tantrum’ Banter

Those interested in the granular take can peruse the linked article (above), but ultimately, selling pressure in European bonds and sharply higher gilt yields following a hawkish BOE piled pressure on Treasurys.

A few folks suggested the Fed may have accidentally contributed by purchasing just one out of more than a dozen eligible securities during its purchase operation. “Some dealers [may have been] left holding bonds they’d expected the Fed to buy, and needed to get rid of them in a hurry,” Bloomberg’s Elizabeth Stanton suggested.

Whatever the case, the 2s10s steepened by 9bps and the 5s30s by nearly 5bps. 10-year yields breached both the 100- and 200-DMAs. “Astute clients have observed there was surely profit-taking at play on flattening trades, especially in the 5s30s spread that dipped below 94bps overnight,” BMO’s US rates team said.

I imagine all of this comes across as particularly quaint to the purported “dumb money.” While our brightest minds spent Thursday trying to solve the mystery of the delayed Treasury selloff, retail investors who eschewed anything like nuance in favor of simply buying stocks on Monday were watching the money roll in.