“Everything’s a meme stock!”, Nomura’s Charlie McElligott exclaimed, in a Thursday note.
He was referring to anomalous moves in German equities and crude, both of which put on a mid-week fireworks show so absurd that I, for one, couldn’t locate an adjective sufficiently hyperbolic to convey just how broken markets really are. Ultimately, I decided on a fatalistic cadence, noting that “there’s nothing to divine” from the current price action, entertaining as it is.
But that’s not entirely true. We can divine one cause of the wild swings in equities, including Wednesday’s rollicking ride on Wall Street and similarly exaggerated moves witnessed seemingly every other session since mid-January. “US equities index / ETF options positioning was certainly a substantial part of the squeeze [on Wednesday], predominately as dealers mechanically covered short hedges in futures against the downside they were short to clients because OTM Puts got wasted on the ripping spot rally,” McElligott said Thursday, referencing the “tinderbox” dynamics discussed at length here on countless occasions.
The figure (below) illustrates just how untethered we are currently. On a one-year lookback, both one-month and three-month realized are 100th%ile.
Importantly, S&P vols were higher Wednesday and index skew steepened into the rally. As Charlie noted, “VIX futures stayed very sticky despite the big spot SPX up move.” That may be foreboding. At the index/macro level, anyway, the options market “didn’t ‘believe’ the rally, despite having to ‘trade it,'” McElligott said.
Thursday brought more whipsaw action across both stocks and crude, which continued to trade in manic fashion amid cross-currents, headwinds and undertows ranging from failed ceasefire talks in Turkey to an ugly US CPI report (the as-expected headline print masked a further broadening out of price pressures, and that was before the worst of the Ukraine-related commodities chaos). A hawkish ECB was insult to injury, even as you might argue the Governing Council was correct to pull forward the end of net asset purchases considering the distinct possibility of a persistent inflation overshoot.
The bottom line for stocks is that nothing is resolved. Nor is it especially likely that anything will be settled anytime soon.
“Equities still have issues going forward,” McElligott went on to write, citing the risk of further CPI upside, a resumption of the move higher in oil (as well as commodities more generally) and his view that, at least for the next month or two, any substantial rally in equities or marked tightening in credit spreads will prompt the Fed to “escalate their hawkish rhetoric in order to try and tame [looser] financial conditions, due to their disastr[ous] inflation problem.”
That latter point will be familiar to regular readers. As Charlie put it Thursday, there’s still an “overhead ‘lid’ on markets.” “Outside of the dealer hedging and exposure management, we remain in a de-gross / VaR-down environment where rallies are sold,” he said, suggesting that’s likely to remain the case “at least for the next few months,” or until the risk of more upside inflation shocks subsides.
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