As you might’ve noticed, some of the most recognizable names on the sell-side are adamant about the elevated odds of a renewed selloff in risk assets, and particularly in equities.
At the least, it’s fair to say many well-known, top-down strategists believe the risk-reward for stocks is asymmetrically skewed to the downside given a variety of factors, including 2023’s S&P re-rating (to ~19x again), high recession probabilities, the prospect of “higher for longer” rates and what many insist will be a deeper profit contraction that bottom-up, company analysts currently anticipate.
And yet, stocks steadfastly refuse to listen. To anyone. Or anything. Earlier this week, one reader posed the following question:
For months, lots of erudite commentaries from smart guys I respect [suggest] the equity market needs to reprice lower. Maybe they’re right, but just not yet, and [maybe] it’s just the market being irrational longer than you can remain solvent. But at some point, doesn’t the onus shift to explaining WHY equities remain bid?
I can answer that. Yes. Yes, it does eventually become imperative for those suggesting stocks “should” retest last year’s lows to explain why they haven’t.
It’s helpful to understand the risks, and I think by now we can all make the same list in that regard. But it’s also helpful to understand why those risks aren’t manifesting in weaker performance.
Once answer is just that it’s all an illusion — that market breadth is very poor, and that were it not for a few names, the market would be lower. Another says there’s always a reservoir of liquidity somewhere — some accidental or circumstantial central bank balance sheet dynamic that’s offsetting QT. As true as those explanations are, they often feel a bit unsatisfying.
On Tuesday, Nomura’s Charlie McElligott offered a trio of more convincing explanations for equities’ recent resilience.
“Stocks continue to frustrate bears, and outside of a ‘better-than-feared’ EPS dynamic yet again, it’s largely been ‘technical’ in nature,” he wrote, before enumerating three key elements. To wit, from McElligott:
- Customer 0DTE options buying creating supportive flows from dealer ‘short gamma’ hedging in both directions,
- The systematic vol-selling side being emboldened with positive returns and ridiculous Sharpes,
- A bigger-picture inflection in bond / stock correlations, which is then having a profound second-order impact into a substantial ongoing vol control re-risking which has been absent for the better part of the past year, where this passive ‘buy flow’ then further acts to suppress vol, feed[ing] the ‘virtuous re-risking cycle.’
As ever, there’s more to modern markets than meets the (untrained) eye.
The comments from McElligot you posted yesterday explained it all. $70 billion of buying from the vol control gang in the first three months of the year.
In fact, I briefly read a reference to a Goldman analysis which suggested that based on other real money flows, stocks “should” be 3% lower. (I need to track it down.)
Vol control and trend following systematic strategies have a finite pot to invest before they get to 90th percentile net exposure. It would be interesting to know how much they have left.
According to BAML, CTAs, risk parity, and equity vol control are all buyers of the S&P 500 this week and a stop loss (full unwind) is not expected during the same time.
In 1994, interest rates moved up far and quickly. Stocks did not sell off like I expected- The money was in shorting the belly of the curve not in shorting stocks. All I know right now is the market is not acting like it wants to sell off…Who could blame people for buying 2 yr or shorter treasuries? As to Goldman’s 3% overpricing of stocks- to someone like me, that’s a rounding error….
Depends on your time horizon. The vol-control folks are not long-term buyers.
My quick read was that the market “should” be down 3% year-to-date, rather than up 8%. So, based on this flows model, 11% overvalued.