“Deliciously weird.”
That’s how Nomura’s Charlie McElligott described the under-the-hood price action in equities to start the holiday-shortened week in the US.
Considering equities’ freedom to move, Monday’s “chop” was the furthest thing from surprising. I explain this dynamic at least once per week. Bloomberg started to cover it regularly earlier this year, but market participants never fail to act perplexed at entirely predictable gyrations in spot.
Read more: Front-Running ‘Semi-Predictable Volatility Storms’
“Well that’s a shocker,” McElligott wrote Tuesday, employing what he called his “heaviest sarcasm font.”
As the OpEx cycle once again left the door open for a wider distribution of outcomes, the market just needed a macro catalyst. Jerome Powell’s renomination fit the bill.
Note that Powell as the catalyst for movement was somewhat ironic. Typically when we think about macro catalysts we mean surprises of some sort. Not necessarily “shocks” in the sense of an incoming asteroid, but rather small “shocks” like an errant headline, a tariff tweet (in the Trump era) or new mobility restrictions (in the pandemic context). By contrast, Powell’s renomination was expected.
It was the read-through of Powell’s second term for rates that “unleashed the OpEx kraken,” as McElligott put it.
The idea, generally speaking, is that ambiguity around Joe Biden’s decision was somehow holding back policymakers. Now that there are no question marks floating over the Chair (with a capital “c”), the Fed can proceed to debate the merits of an accelerated taper and, by extension, an “early” liftoff.
Bonds reflected that, with the bulk of Monday’s pain in Treasurys concentrated in the belly. Rate hike bets were evident in eurodollars and traders priced in a full 25bps hike for June with another in November. Back-to-back auction tails exacerbated the situation.
“Inflation breakevens collapsed and real yields exploded higher… because the market was ‘green-lighted’ to further price a faster taper in order to pull-ahead more rate hikes,” McElligott wrote. But the “real story,” he said, wasn’t the intraday reversals on the benchmarks (which, again, were free to move as the insulation dropped off), but rather the devastation in ultra-rich, profitless growth shares. Bloomberg highlighted the same on Monday and again on Tuesday.
There are two key, related points. First, higher real rates are kryptonite for richly-valued shares. Second (and this is not well understood even by some ostensibly “sophisticated” investors despite being straight out of the first three chapters of any basic finance textbook), if you’re long high-multiple, profitless growth stocks, you’re essentially long duration with leverage.
“Even though index did indeed move, there was a massive dispersion of performance,” McElligott said, describing Monday’s equities action. That dispersion meant that the index-level moves were relatively pedestrian, as outperformance for some cyclical value plays offset losses in duration- and rates-sensitives.
Charlie described “bloodshed” at the factor and thematic levels, and acute “pain” for managers “who’ve been hiding in the ‘bond proxy’ hyper-growth / no-profit stuff.”
That pain can have knock-on effects, something Bloomberg astutely picked up on in the first linked article above. “It could be bad timing or it could be a case of selling begetting selling, considering the growing concentration of [high-growth, high-valuation stocks] to extreme levels in the portfolios of professional speculators,” Lu Wang wrote, flagging “notable losses in a few companies that don’t fit the high-priced tech definition but are also hedge-fund favorites” as “evidence that positions are being unwound.”
The single-name “bloodshed” and “pain” described by McElligott could well have prompted an unwind across tech and may well have contributed to the poor close.
“In a world of rising rates, portfolio managers need to differentiate between unprofitable growth stocks and those with elevated profitability,” Goldman’s David Kostin said late last week, adding that Goldman’s recommendation is to “avoid fast-growing firms valued entirely on long-term growth expectations, which will be more vulnerable to the risk of rising interest rates or disappointing revenues.”
While the above may be lost on many investors, some folks understand it all too well, which is why, as McElligott went on to say Tuesday, “a number of large investors have bot a significant amount of ‘crash’ in these expensive hyper-growth / unprofitable names.” You might, for example, view downside protection on something like ARKK as a proxy for your bearish rates view.
It’s been a rough month (table above).
Hopefully, you can write the rest of the script yourself. “Dealers are short a lot of gamma in bunches of these rather illiquid names where there aren’t many functional hedging alternatives besides the ability to wack QQQ’s or TSLA,” Charlie said, noting that Monday’s “‘liquidation-looking’ price-action” may well have been partially attributable to that setup, as hedging flows exacerbated tech losses into the close.
ARKK was down another 3% by noon on Tuesday, extending this month’s decline to more than 13%.
You must be logged in to post a comment.