Rolling The Dice On A Falling Knife

Who’s inclined to catch a falling knife?

Not me, I’ll confess. Or at least not in equities. I did attempt some falling-knife-catching in bonds late last week. That chancy endeavor was going swimmingly on Monday amid risk-off sentiment tied to China growth fears, but I’d put it squarely in the “don’t try this at home” bin.

As for stocks, I’m wary, not because I doubt there are tactical upside opportunities, but rather because I try to confine by equities activity to long-horizons. That’s a product of a life partially spent gambling on… well, on my life, frankly. Show me a hedge fund manager you’d characterize as a risk-taker, and I’ll show you a hedge fund manager who’d sooner show up to a Hamptons party in a Honda Civic than take some of the risks I’ve taken. Gambling with money is one thing. Gambling with your life for money is another entirely. (Ah, the “good” ol’ days.)

All of that to say that I’ve taken enough risks in my life without having to fret over every thematic swing and factor rotation at a time when we may be witnessing an epochal macro regime shift. But, for those who don’t suffer from mild PTSD associated with the “glory” days of your own personal “yore,” it could be worth taking a stab on the tactical bullish side in stocks.

Why? Well, because the zeitgeist is overtly bearish and some of the near-term event risks are set to clear, with big-tech earnings, the May FOMC meeting and April payrolls all set to “roll off” within two weeks.

“The equities mood is just so mixed, with conflicting signals which are bleeding conviction and lead[ing] to these daily reversals and persistent ‘chop,'” Nomura’s Charlie McElligott said Monday.

“I will say this, though: Convos with clients are increasingly noting a building desire to get more constructive on equities over the next two week period, on account of enhanced earnings visibility and ‘imminent’ Fed policy visibility,” he added, noting that the May FOMC meeting could “act to ‘shrink the distribution’ of rates outcomes,” given it’ll provide a measure of clarity on runoff parameters, the timeline on any prospective pivot to active MBS selling and, of course, the appetite for hike increments larger than 50bps.

Sentiment, Charlie noted, is “bombed-out.” The AAII “skew” (for lack of a better way to describe an indicator I personally don’t consult, even as I readily admit to being in the minority on that) is now -2 standard deviations (figure below).

JPMorgan’s Marko Kolanovic has similarly pointed to AAII sentiment as a possible contrarian indicator.

McElligott continued. “As we hit the low-end of the YTD range trade and looking across the aggregate of inputs, the pros for building a tactical equities long / buying the pullbacks over the next two weeks are mounting,” he said, citing investor despondency and systematic positioning which has “negligible further downside versus lots of blue sky to the upside.”

At the same time, we’re back to extreme Greeks. The huge negative Delta in options positioning (figures on the right, below) are dry kindling in a squeeze scenario where spot runs away to the upside and hedges get unwound.

Any constructive case for stocks (even on a tactical, short-term basis) depends on no additional violent escalations in the rates space and, relatedly, on the end of anomalous inflation overshoots.

The Fed is in full-hawk mode and price pressures will linger, we know that. But the episodic escalations (e.g., the uber-hawkish rates expressions that defined the latter part of last week) have to stop for stocks to stabilize.

But if you’re the adventurous type who sees opportunity in sentiment extremes, there may be something to be said for rolling the dice on near-term equity upside.

“Equities are held hostage by sentiment thrash, with grinding deleveraging evident in fund outflows and systematic positioning at extreme lows,” McElligott went on to write Monday, citing “huge” demand for hedges and “absolute tanking investor conviction,” all set against a pervasive “recession / hard landing” theme.