Stocks: Don’t Believe Everything You Read

Nearly three months into 2022, US equities are largely indecipherable.

There’s nothing unusual about market participants and journalists retrofitting a narrative to the price action or resorting to humorously belabored attempts to explain stocks’ behavior by reference to a set of incompatible headlines. What is somewhat unusual, though, is the extent to which media outlets themselves are now skeptical of such efforts.

“Remember when equities were infinite-maturity assets with elevated valuations justified by low interest rates?”, Bloomberg’s Cameron Crise asked. “Apparently now they’ve transmogrified into zero-maturity floating-rate notes that hedge inflation risks via adjustable revenue streams,” he went on to joke.

The terminal dwellers among you will note that only Crise would use “transmogrified.” He’s a gifted writer, but sometimes his attempts to conjure chuckles with words rarely heard in the wild elicit more eye-rolls than laughs.

Writing in a Thursday note, Nomura’s Charlie McElligott made the same point without using the thesaurus. “How did we go from the ‘inflation hawk, Fed pivot that created the past five-month equities zeitgeist of ‘higher interest rates / FCI tightening = destruction of high-multiple stocks that are really just long duration assets’ to suddenly now, over the past two weeks, the TINA argument of ‘higher interest rates benefit stocks, because they act like TIPS but with pricing power?'”

The answer, of course, is that the vast majority of market participants don’t like to admit that equities can be driven almost solely by positioning and flow dynamics they don’t fully understand for extended periods of time. Instead, investors and journalists spend their days playing what Charlie called “pin the tail on the narrative.”

For weeks, stocks were a viciously raucous affair, the result of extreme Greeks. The good news is, there’s been “a broad shift in options dealer positioning across US equities Index / ETF majors back to market stabilizing ‘long gamma,’ which acts to compress vol and trading ranges,” McElligott said. He did flag one “pocket” of local short gamma associated with a large options position. Without delving into the specifics, suffice to say 4,510 matters.

What I wanted to highlight here is the scope of systematic de-leveraging as quantified by Nomura’s models. This is helpful, as it gives you an idea of what you’re not hearing about when you read daily market wraps published by whatever mainstream media outlet you prefer. Consider these bullet points from Charlie:

  • CTA Trend had sold ~$150B (from “long” to “short”) since mid-Nov ’21 to the Jan “max short” lows across Global Equities futures  per our model estimates (at late Jan ’22 “max short” lows, down to 0.2%ile Net Eq Exposure since 2011)
  • US Equities Vol Control had de-allocated ~$145B of Equities futures over the past 6m on the vol reset which came with the global central bank “inflation hawk” policy regime shift, meaning FCI from “easy to tight,” as legacy positioning was unwound “From Duration to Inflation” (at Mar ’22 lows, down to 9%ile Eq Exposure since ’11)
  • All while Risk Parity had de-leveraged $53B of Global Equities from the pre-COVID VaR shock highs (at Feb ’22 lows, down to 2.1%ile Eq Exposure since ’11)

I’d suggest that for most market participants, the %ile rankings McElligott includes are perhaps more insightful than the numbers themselves. If you’re truly immersed in this, the scope of the de-risking is meaningful, but for everyday people, those are just “big numbers.” If that’s you, the %ile rankings are probably more useful, as they help you get a sense of how “complete” the systematic positioning purge was.

The read-through, obviously, is that if vol recedes and markets manage to retain some upside momentum, those strats will dial their exposure back up. And, in fact, first-mover CTAs already have.

“CTA Trend has covered and is now back to an aggregate ‘net long’ position across all global equities futures in the model, adding ~$49B off the lows and with ~$32B of that in the past two weeks alone,” McElligott went on to say.

As for vol control, realized has to reset lower in order to trigger lagged exposure adds. The figure (below) is a reminder of just how topsy-turvy things have been since the December Fed minutes were released.

“Vol control is slower moving,” McElligott wrote, noting that if you project daily S&P changes of 1% over the next month, that would entail more than $20 billion in increased exposure. The figure goes to almost $27 billion if equities settle into a more pedestrian range with daily changes confined to a 0.5% band.

As for risk parity, Charlie flagged “substantial re-leveraging across global equities positions as the COVID shock rolls out of our lookback window.” Equities exposure there is now back up to the 32%ile.

Finally, those wondering about rebalancing flows are left to ponder the vagaries of a market hostage to the flows you don’t hear about. “Estimates into the start of last week were for a ‘buy’ of equities, but that was before a 9% rally in the S&P thereafter!”, McElligott exclaimed. “So instead, the flows have reversed, turning ‘buy bonds, sell equities’ on the pension rebalancing.”

How’s that for transmogrification?

Leave a Reply to artillery Cancel reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

7 thoughts on “Stocks: Don’t Believe Everything You Read

  1. My risk model has been saying lately historical volatility is up- which is what your article also suggests. As a manager of other people’s money this would suggest a contrarian should buy, since volatility is often mean reverting. I am sitting it out, but I am not selling. The market in the short and intemediate term is a beauty contest and is largely driven by sentiment. Over the longer term (say 5+ years) markets are weighing machines and are more earnings and results driven (paraphrase Buffet/Munger). As the article suggests if shorter term volatility levels out – there is ample incentive for trend followers and everyone else to buy. The most solid thing for the market in my view is to have a flattish year to take some of the froth out, without upsetting the apple cart. As the rolling stones said once, you can’t always get what you want, but if you try so hard, you can get what you need… (or something like that).

  2. Great summary of systematic exposure adjustments we have seen, really appreciate you distilling it for relative laymen..

    But I see nothing incredulous in the TINA argument.. we are seeing a second cost-push bout of inflation with the commodities disruption due to russian aggresion in ukraine after the lockdown induced bout of the last two years.. I have absolutely no desire to hold cash, even if productivity growth stagnates, and we move the same number of “things” the price of those things will go up, and therefore so will earnings, in dollar terms… in an inflationary environment (ie always) cash is not a store of value, it is only a facilitator of transactions… you have to own “real” assets, and apart from real estate and infrastructure, stocks are about the best approximation of a real asset we can all access.. (accepting they are actually a figment of our collective imaginations..)
    As far as multiples go.. the SPY is pricing about 17.5x next years projected earnings.. not horribly expensive if terminal rates are in the mid-high 2’s

    Prices dont go down because the news is bad, they go down because people sell things.. as a fundamental investor (rather than a manager of greeks or systematic trading programmes) you would only sell stocks because a. There is a better investment opportunity b. You need the cash or c. You are confident that you will be able to re buy your portfolio at a lower price..
    it is not obvious to me that if I sold my stocks I will execute the buying back cheaper, as you discussed in an excellent piece a week or so ago, despite the fact that I may very well have the opportunity to…. So you sit it out… I dont know anyone that has sold any stocks, so why should the market not rebound, once the machines have done there work ?

    Once again, we are “looking through..” ?

    1. I’ve happily sold a lot this week after sifting through the smoldering ashes earlier this month. Always happy to have a fair amount of cash to deploy when the opportunity arises. I see no reason to be a hero here. Will I miss out on a SPY move to $480? Maybe. But the odds of SPY $420 are greater than SPY $480 at this point, IMHO.

  3. I also think that given previously frothy tech stocks (im talking pypl or sq not googl or msft) seem to have held their lows and bounced, we are weeks away from a call for a rotation back into growth vs value..

    Possibly I am too cynical, but the portfolio churn of calling for a regular rotation is part of the IBs business plan and an important revenue stream..

  4. I’m starting to wonder if the next few months could turn out fairly positive for equities. We’re past lift-off. If the strats are back, that’s unabashedly good. If we’re pricing in a 50pt move at the next one or two meetings plus announcing a balance sheet reduction plan, then the Fed may, for once, seem to be back in front of the problem (evidenced by H’s “Fed may only deliver half…” article — we’re finally having to worry that the Fed might actually overdo it). Lastly, if we get any data that hints at inflation topping out, or some credible hint of resolution in Ukraine, then a glass half-full interpretation could emerge with the Fed narrative shifting from “the Fed won’t be able to …” to “the Fed may not need to …”, resulting in fewer hikes without the messy meltdown. After all, in the interest of sorely-needed stability in these times, the Fed could opt to trade fewer hikes for more time so long as inflation is at least drifting back down.

    And worrying about a possible recession a year or more from now? Fine, it’s on the table. It’s not like that particular risk has ever really been off the table throughout our entire adult lives.

  5. I agree uptownguy.. the market loathes uncertainty, and it feels to me that the market is viewing the current dot-plot as credible and reasonable, which has bolstered confidence..

    Re: balance sheet reduction.. i haven’t seen the numbers recently, but are reverse repos still north of a trillion dollars ? or did the vol blow out suck that away.. if it is, the financial economy doesn’t really need the feds cash.. they are blowing and sucking at the same time..

  6. Red.. you maybe correct that 420 is more likely than 480 in the short term.. and 420 might trade… id give it 30 pct probability..

    Dont know about you, but id give myself about 5-10 pct probability of buying it the day it trades.. and id give 70-80 pct probability to it trading 480 in the next 24 months..

    I am shorting my ability to buy when people (including me and possibly you) are fearful

NEWSROOM crewneck & prints