On Monday afternoon, after another brutal selloff in US tech shares briefly pushed the Nasdaq to the brink of a technical correction, only for the index to abruptly reverse course, I noted that divination was complicated by the likely impact of hedging flows.
There were some ostensibly constructive takeaways from the bear flattening in rates (e.g., one interpretation was that the market expressed conviction both in the Fed’s willingness to cool things down and capacity to succeed), and the inability of the long-end to extend the selloff likely helped stanch the bleeding in growth shares.
But stepping back from the fundamentals and focusing on what really matters on a day-to-day basis, Nomura’s Charlie McElligott on Tuesday noted that the mechanical impact of closed puts probably contributed to the Nasdaq’s epic reversal. “Negative / short Delta accumulated for Dealers who were short QQQ Puts [and] downside to hedgers then meant… significant $Delta to cover as spot rallied higher and higher off the lows,” he wrote, adding that “as outstanding Puts went further OTM [that] also caused Delta to be bot back, all of which incentivized further monetization of hedges in a virtuous feedback loop.”
If you’re looking to explain the Nasdaq’s turnaround to start the week, that’s the short version. McElligott went on to flag the collapse in implied vol (five vols off the highs hit an hour into the session) which, he said, “contributed to Tech shares’ boomerang higher” given the positive Delta impact. It’s likely that quite a bit of the underlying exposure has been shed (or maybe “bled” is better) over the past two months, which, as Charlie also pointed out, partially explains why vols didn’t stick following Monday’s early rout.
Market participants were hedged given the readily apparent hawkish shift in monetary policy which has obvious (negative) ramifications for tech and potentially dire consequences for profitless tech, “hyper-growth” and various manifestations of quasi-leveraged duration in equities. That’s especially true given legacy longs both from a decade of conditioning (i.e., the benefits that accrued to secular growth stocks from the “slow-flation” macro regime) and the more recent turbocharged bullish dynamic created by the pandemic.
The “very rational and relentless demand for Tech / Growth downside” manifested in extremes in Skew, iVol / rVol, ATM Vol and Term Structure, McElligott went on to say, recapping. Thanks to all of that downside protection, “there’s simply less hedging required at this point,” he remarked. The figures (below) illustrate a much less acute situation from Monday to Tuesday morning.
On Monday, I wrote that with analysts now falling in line around four 2022 hikes and runoff starting by summer, it’s not clear what the catalyst would be for markets to price in additional hawkishness. That potentially opens the door to reversals, however fleeting, both in rates and equities expressions sensitive to higher long-end yields.
But, that came with the following obligatory caveat: Plainly, the most expensive corners of the US equity market are inclined to additional de-rating absent some sign from Fed officials that the market is ahead of itself on either the pace and number of rate hikes, the start date for balance sheet runoff or both.
Unless and until inflation shows signs of normalizing, thereby reducing the political pressure on the Fed to “do something,” market participants will likely approach speculative tech with extreme trepidation.
“Medium- and longer-term, I’m not sure investors are going to fully plow back into the ‘expensive’ / ‘hyper-Growth’ stuff again beyond these counter-trend rallies,” McElligott said Tuesday.
Instead, he suggested, traders will “continue preferring ‘Value’ at this juncture in the cycle, largely because ‘sticky’ higher inflation continues as a bipartisan political issue for the Fed.”
And yet, as SocGen’s Andrew Lapthorne dryly noted last week, “playing inflation via equities is a risky business, with stocks that tend to benefit from higher inflation historically having a poor long-term performance record.” “After all,” Lapthorne quipped, “being long inflation has generally been a bad idea.”
