Capitulation in equities is “only partial.”
That was the message from Barclays at a critical juncture for markets. I realize “critical juncture” is overused. It’s always a “critical juncture” according to someone, somewhere. But Thursday will mark peak earnings season in the US and Europe, with nearly $10 trillion in market cap reporting, and Wednesday could be remembered as the day the Fed’s most aggressive tightening push in decades crescendoed, at least in terms of the amplitude of rate hikes.
“The bulk of equity de-risking YTD has come from HF/systematic funds,” Emmanuel Cau wrote. “Their exposure is short and, as recent weeks showed us, prone to covering.” Indeed, CTAs have likely covered more than $40 billion in equities over the past two weeks, according to Nomura’s models, which suggest US stocks would need to rally an additional 9% in order to trigger more buying from trend followers. As Barclays put it, positive market momentum needs to hold.
Mechanically, vol control “should take the systematic reallocation baton in the coming weeks,” Nomura’s Charlie McElligott said, reiterating that three-month trailing realized is set to recede as a handful of especially lively sessions fall out of the lookback. The bank expects somewhere between $10 billion and $30 billion in bought-back equity exposure from vol control over the next month. Barclays’ Cau echoed the sentiment, noting that risk control funds will be buyers as realized volatility moderates. The figures (below) offer a snapshot.
Generally speaking, this is the story of the recent bid for equities. Positioning was light, and the market started to move in the “wrong” direction. “The equity bounce so far in July was mainly due to short covering,” Barclays said.
Additionally, the unwinding of hedges into the rally was a synthetic bid. “The prior ‘over-hedging’ regime has been largely washed out… hence, we’ve seen the once prolific ‘extreme Negative $Delta’ across combined high-profile US Index / ETF Options come off the boil,” McElligott wrote earlier this week.
The closing of hedges “as we rallied away from down strikes… acted like a de facto +$415 billion short squeeze over the past month,” he added. The figures (below) illustrate and quantify the dynamic.
All of the above is “mechanical” in one way or another. On the non-mechanical side, it’s a story of obstinance or obliviousness, depending on your penchant for derision.
As documented here on innumerable occasions of late, there’s been no surrender from real money investors. “Capitulation seems far more elusive than for the leveraged funds community,” Cau remarked, noting that although equities have seen outflows recently, they’re “small in magnitude.”
The updated figure (below) gives you a sense of the situation. On net, equity funds have enjoyed $178 billion in inflows this year.
The capitulation is in bonds, not stocks.
As a quick aside, BofA’s clients are starting to favor stock-picking versus passive investing. Client ETF inflows slowed again last week, for example, and single-stock activity is the most positive in three years in 2022, the bank’s Jill Carey Hall said. Nevertheless, Barclays noted that “the most popular US equity ETFs continue to see small inflows.”
At some point, the cognitive dissonance inherent in the disparity between fund flows and the bear market will need to resolve, either by investors hitting the exits or stocks somehow “proving” that the lows are, in fact, in.
Just a few dollars has come out of global equity funds for every $100 that flowed in since the beginning of last year. The figure on the left (below) shows you the scope of the disconnect.
“It is the norm for equity flows to follow performance [but] the gap between the two that opened up YTD is unusually wide,” Barclays Cau said Wednesday.
At the least, fundamental investors and the discretionary crowd will have something like clarity on earnings after this week, even if the retailer “shoe” continues to drop. As for the Fed, “clarity” isn’t forthcoming given central banks’ collective decision to jettison forward guidance in favor of a meeting-by-meeting approach. But after Wednesday’s hike, the Committee will be close to neutral — that’s “not nothin’,” as they say, especially considering how rapidly it was achieved.
Of course, there are still more recession questions than recession answers. Not least of those questions: What even is a recession? As it turns out, nobody is really sure.
Certainly, recession angst hasn’t shown up in aggregate equity flows. Yet. “So, recession is on everyone’s lips, but it is yet to be confirmed by MFs dumping shares,” Barclays wrote, adding that “around past recessions, cumulative equity outflows amounted to ~3.5% of AUM on average.”
Currently, that figure is just 0.1%.
It sure looks like BTFD is still very much alive and well.
So consumers stopped going to Walmart this past spring, when, instead, they bought airline tickets for a summer vacation…..So where are the (possibly dwindling pool?) of consumers going next? I just read airline ticket prices are already expected to drop this fall, as demand drops and kids go back to school.
I can not imagine trying to invest based on this current pattern of short- lived trends, let alone guess the next trend.
All I can think of is all of the head spinning that happened in the Exorcist.
Re: https://heisenbergreport.com/2022/07/21/microsoft-may-hold-keys-to-yikes-pain-trade-rally/
I have no idea where things are heading today- so far it doesn’t look to me like a Yikes! pain trade rally in response MSFT and GOOG reports, though MSFT after hours yesterday went pretty close to how McElligott outlined it might in the piece above. And with McElligott’s take yesterday on the Fed talking Hawkish being my base case, I guess I’m not seeing how we get to Yikes Pain Trade from here.
Well, MSFT +5%, Nasdaq +2.3%, etc., all pre-FOMC obviously. FWIW, Charlie rated his own MSFT thesis today: “It was kinda prophesied here last Tuesday (I’d give it a “soft 6.5” out of 10).”
This post, shared yesterday by H., was informative for me: https://heisenbergreport.com/2022/07/26/define-pivot/
When the next chapter of the pain trade comes will depend on how the Fed talks about this stuff. How Jerome Powell frames the rate hike today can make the difference in how the market responds, and whether we see more pain this summer or in the autumn.
What I really want, though, in parallel, later this year, is to gain greater foresight to resolutions of the Ukraine war and supply chain disruptions in China, each of which is inspiring global inflation. Fingers crossed.
Yes, if this episode of “McElligott” were on Netflix, it would be tagged “slow burn”, measured in trader time 😉 But if we get past the remaining hurdles of this week, I suspect his thesis may prove correct soon. The weak data we’ve seen lately is supportive of a relatively quicker resolution of inflation, continuing the trend of fast economic developments post-Covid (notably, with labor as a large caveat so far). Inventory overhang everywhere? That has a quick resolution and it is Fed-supportive. Housing transactions down 20% YOY? What can Powell say? “No that’s not good enough, it needs to plunge 40%!”? In fact, housing is on track to support the Fed nicely going forward. The speed of weak data supports staying the hawkish course without hitting the brakes harder, and it also encourages markets to look past near-term ugliness. If the lookahead trade-off, following a 2Q earnings season that wasn’t bad enough, is “recession earnings weakness” vs. “inflation drivers cooling”, I suspect the latter will win and equities will respond, mechanically and otherwise. Not thinking ultimate bottoms, here, just the post 2Q picture.
uptownguy, ChgoDave, therealheisenberg: Appreciate the replies. Will be interesting to see if McElligott’s triggers for CTA covering/buying from last week’s article get hit. He’s being modest for giving himself 6.5 for hitting the initial phase of his thesis right. Thanks!
I’ll admit equity inflows during this bear market is a puzzle, unless the reason is as obvious as some portion of cash from bond capitulation having to flow to equity funds instead of money market funds.
This amateur investor thinks this may be due to the highly repeated and somewhat misleading statement that stocks are an inflation hedge.
In a Recession the strong get stronger (big tech).
With the Fed raising interest rates so rapidly who’d buy a bond when you can wait a month and get more?
(Who wants to lock their money in at 2% when inflation is 9%?)
They’re probably not throwing their money at an only-now-cooling-from-super-hot real estate (and now higher mortgages to boot).
They’re probably wary of investing in China or Europe, and definitely not thinking Russia or Argentina.
So maybe some people are thinking that 9% less buying power (of real estate or cars etc) with cash is a problem.
But US equities are liquid, and if the S&P goes down 9% at least they’re getting a small dividend… and hoping the market’s bottomed and so will go up.
That being said I’m mostly cash waiting to understand/predict how to not fight the Fed.
To me… it looks like the boys (and girls) that own the majority of the stocks (the top ten percent) aren’t missing any meals, the gas tanks on their German sports cars are full and they’re not only not selling their high yield stock, they are setting the floor for them and buying the dips. I think I’ll ride on their coattails for a while longer.