Equities are an “untradeable mess.”
That’s apparent to anyone trying to trade them. The maddening chop is conducive to fatalistic sighs and furrowed brows.
But what’s important is the context — the “why,” if you will.
On Wednesday, Nomura’s Charlie McElligott attributed the situation to two main factors, which are feeding into (and in some respects, off of) one another, as tends to happen in modern markets.
The first is simply “macro tension.” “The fact is, both domestic and global growth is much better than everybody feared in their faulty ‘H1 recession’ meme,” Charlie wrote, noting that assumptions about an imminent downturn left many under-positioned into 2023’s early-year “everything rally,” and particularly vis-à-vis stocks.
“Equities underweights [were] forced to adjust, adding net exposure again [and] the multiple expansion boost seen in January as bonds squeezed and rallied, lifted last year’s ‘worst of the worst’ and mega-cap tech duration proxies,” McElligott said, describing both the dash for “trash” and the re-rating in the Nasdaq 100.
With rates rising again, and terminal rate expectations now repriced nearly two full 25bps hikes from the 4.80% local lows, that re-rating (and certainly the rally in “junk” stocks) is vulnerable. We could, McElligott cautioned, “reverse again into a fresh bout of multiple compression due to the ‘come to Jesus’ likelihood of a higher neutral rate, which necessitates a higher terminal due to underlying inflation, labor and wages all continuing to run ‘too hot.'”
Importantly, he pointed out how this is interacting with the proliferation of very short-dated options to create a to and fro dynamic worthy of Dramamine.
“Over the past 10 days of S&P futures trading, we have witnessed an absolutely ridiculous 14 intraday swings >1%,” Charlie wrote.
Given prevailing macro crosscurrents, conflicting economic signals and pervasive ambiguity, it’s note terribly surprising that stocks should be a choppy affair. But, again, the intraday price action strongly indicates that “brave new markets” are facilitating a see-saw.
“Two-way macro tensions [are] feeding into a market structure dynamic that exploits these swings,” McElligott reiterated.
The chart above is familiar to regular readers and the accompanying table gives you a sense of what we mean when we say “pervasive.”
“The 0DTE option phenomenon [is] growing more powerful and prevalent by the day, where on average over the past month, nearly one out of every two options traded on SPX, SPY and QQQ are 0-days-til-expiration,” McElligott said, summing it up.
As Cameron Crise put it earlier this month, “The nature of trading in US equities has shifted notably in recent years [as] the explosion of 0DTE contracts [is] creating substantial flow and pockets of illiquidity that are impossible to model beforehand.”
Related: Brave New Markets
