The mechanical rally that found US equities closing out an otherwise abysmal quarter on a high note is obscuring macro headwinds and a tightening impulse that’s poised to become more acute.
That was one message from Nomura’s Charlie McElligott who, in a Wednesday note, described Lael Brainard’s updated policy outlook as “full-tilt inflation hawking.”
Brainard’s remarks were both emphatic and specific, reinforcing market expectations for determined rate hikes and an aggressive approach to QT, which together suggest the cumulative “delivered” tightening in 2022 could end up being off the proverbial charts.
“Get your head around this: Historically ‘dovish spectrum’ Brainard opened her speech by citing both Paul Volcker and Arthur Burns!”, McElligott exclaimed, adding that a renewed “shock tightening” in financial conditions courtesy of “exploding” real yields “is allowing ‘macro truths’ to finally override recent bullish mechanical flows in equities.” The figure (below) illustrates the point.
That matters. A lot. That’s 100bps higher (i.e., less negative) in 15 sessions.
“I’ve learned to put a lot of weight on ‘impulse’ tightening in reals and the second-order impact that should have on risk asset positioning and liquidity,” McElligott said Wednesday, calling the current rally in stocks “incoherent with what’s happening in financial conditions.”
Charlie also cited the one-week change in the TIPS 2s10s curve, which he noted was “the largest impulse flattening since the US debt downgrade in Aug 2011 and December 2008.” The stacked charts (below) illustrate that, alongside a readily accessible measure of financial conditions and rates vol, all juxtaposed with oblivious equities.
For weeks, I’ve suggested the rally in stocks was almost purely a function of positioning and flows. That doesn’t mean it wasn’t “real.” Readers sometimes misconstrue my point when I suggest, as I did on March 24, that when it comes to stocks, you can’t always believe what you read in various market wraps prepared by mainstream news outlets.
It’s not a conspiracy, and it’s not (necessarily) that anyone is being deliberately obtuse. Rather, it’s that the “real story,” so to speak, is somewhat esoteric and not generally amenable to wider audiences. Recent gains on the benchmarks were just as “real” as any other gains, but it was imperative that serious market participants understood the dynamics that drove them. Because those dynamics don’t fit well in mainstream media market summaries, most investors are left in the dark.
Summarizing on Wednesday, McElligott wrote that “it’s still very much my view that the largely mechanical flows are masking a lot of brokenness out there.”
In addition, he reminded market participants that equity rallies are, in some respects, counterproductive for a Fed desperately trying to tighten. The more resilient stocks are, the more aggressive the policymaker rhetoric is likely to be.
“Remarkably stable stocks allow the Fed to continue to lean into financial conditions and hawkish rhetoric,” McElligott wrote, calling that the “core concept” behind his contention that the Fed is effectively selling calls, “limiting the market’s ability to break out of the same 4200 / 4650 range-trade.”
The Fed is in a situation, I believe, to make or break the November elections. I also read yesterday, that Biden plans to extend the moratorium on student debt repayments for the 5th time until August 31- which will make it an election issue.
I would have agreed a year ago, but this close to the election, the FED can’t do anything to “cure” inflation in time for the election, and inflation is what will make or break (okay, let’s be honest, it’s break) the election.
On the loan moratorium, I speculate Biden will just kick that can indefinitely. As long as a Democrat (any Democrat) is in the White House, they can indefinitely extend the moratorium, and if/when a Republican retakes & reinstates, then Republicans will be the ones to take the political heat.
The market (sp500) went straight up from 3/14 through 3/31, a +9% gain over two weeks. A lesson in the potential of “mechanical” flows. I hadn’t thought such flows could drive the market that far over that long a time.
@jyl
One reason I first signed on here at heisenbergreport was for the resident take on these “mechanical” flows you speak of. As a along time avoider of broker margin account usury and financial flim-flam artistry in general I’ve been able to comfortably take the moral high ground and look down upon the whole derivative-zation of anything and everything possible for inclusion into the Market making indexing machines, at least, until the GFC. I would have hoped lessons might of been learned and precautions taken, but, that was naive. Naive do due to too many reasons to list in their entirety. So I’ll just toss out a couple. A profound ignorance of the American Political Economy (APE) studies (an offshoot of Comparative Political Economy (CPE) studies) at the time. A vague understanding of the real impact of computerization on Markets and especially a lack of appreciation for accelerating Rate Of Change. Plus, being lulled by the steady gains reaped from Globalization, I failed to appreciate the risks of the forces of Financialization and Neoliberalism merging and overextending their reach/success at the expense of other factors…. Do I still “look down” on these “mechanical[s]”? You betcha. One of many reasons is, as we often read here, is the current ‘system’, which we were ‘sold’ on as a liquidity booster and thus market efficiency enhancer, is constantly engendering worried quotes from the ‘system’ participants about lack of liquidity and escalating ROC in liquidity drying up. So much so, it even periodically necessitates, the FED to save these wizards-behind-the-curtain from losses with public money backstops. You know, the old saw about keeping the gains private (majority shareholders, think Asset Management Capitalism perhaps) and the losses public (taxpayers). The FED’s/Central Banker role in Financialization of the American/OECD economies and their constituent players is critical, as ‘it is about the debt stupid.’ Of course, there are the worrying issues with market-makers being disincentivized to the detriment of bid-ask spreads and so on and so forth.
“The use of computer algorithms for trading has been on the rise in the U.S. equity markets since the turn of the century but seems to have plateaued around 70-80 percent in the last 5 to 10 years. As of 2003, algo trading accounted for only about 15 percent of the market volume, but between 2009 and 2010, more than 70 percent of U.S. trading was attributed to trading algos. The foreign exchange markets also have active algorithmic trading, which is measured at about 80 percent of orders in 2016 — up from about 25 percent of orders in 2006.”
Do your own Due Dil[bert]igence of course. I haven’t. I don’t feel a strong need to research it cuz I, not unlike the proverbial frog in the pot of water on the stovetop, I’ve been living it and I know it is bad. Far worse than the ‘media’ would have readers believe. To do otherwise would shred the myth their advertisers wish to propagate, I suppose this based on the assumption that when Homo economicus behavior does not correspond with reality, then follow the money for possible answers. On the other hand, this doesn’t mean, for me at least, that Behavioral Economics and Narrative are obsolete. Both still apply to the lies we tell ourselves as we ramp up or down the animal spirits we call upon before we engage in trading/speculation via the mouse button. I have that on no less authority than John Maynard Keynes, a bad ass speculator if there ever was one.
The more disassociated the media feed gets from trading reality the more I feel forced to turn toward TA in times of transition/rotation/chaos. So why would algos have “plateaued around 70-80 percent”? That’s the crux ain’t it? One, obviously, it has something to do with maximizing Financial-Industrial Complex profits. Is it sustainable? That will depend on how well the vampire squid of financialization can continue to dominate the politics of the regulatory and policy processes. After neoliberalism and financialization melded they have excelled at that domination. Interestingly, Blackrock has made inroads into the Biden administration. Same Industrial-Complex but a member with a slightly different take on the world than Goldman and Bros. Anyway, besides feeding the Media-Myth machine revenues, why do the algos/HFTs need (or merely want?) us “carbon” traders hanging around? Out of habit? Tradition? At what point will all “narrative” be reducible to equations? Of course, the only equations that will evolve and survive are derived from narratives suitable for HFT code. Maybe Homo saps is still useful because code can’t do context yet? It is tempting to go algo-contrarian and just trade in time frames ill suited for energy hungry machines. Seems intuitive. After all, it is one of the well established Media investing memes/myths, “Buy & Hold.” Which raises the question, how much of our Market narratives are spoonfed to us unconsciously? As in, we ‘understand’ only what we’ve been feed/led to. Maybe, algos/HFT have plateaued around 70-80% because the ‘system’ will collapse beyond that and the Financialization+Neoliberal-Industrial Complex would lose money (i.e., influence in a pay-to-play post Citizens’s United environment…) and thus be forced to share/return power? But with/to whom? … Times are a-changin’.
Maybe, now that the Market is closed for the day, I’ll go to the liquor store and buy a lottery ticket.
Bored waiting around for the Sockapocalypse? Want something fun and uplifting, yet pertinent, to read?
Try, “Stock Market Charts You Never Saw”
54 Pages Posted: 11 Oct 2017 Last revised: 17 Mar 2021
Edward F. McQuarrie
Santa Clara University – Leavey School of Business
papers.ssrn.com/sol3/papers.cfm?abstract_id=3050736
Thank you for sharing! Definitely not something my broker or anti-Social Security politician would share.