One thing sticks out as “spooky and dangerous” when set against months of simultaneous re-risking by both systematic and discretionary investor cohorts.
The “complete flipping of the equities positioning script is occurring against the exact same skew profile seen in late 2022,” Nomura’s Charlie McElligott said Wednesday. That “speaks to complacency,” he cautioned.
Skew and put skew currently rank very low on a historical percentile basis, indicative of subdued “relative demand for downside,” McElligott wrote, adding that call skew is still lingering with mid-90%ile rankings, suggesting market participants are far more concerned about crash up risk into a rally that refuses to abate.
That under-hedging on the downside juxtaposed with what Charlie described as “stuffed overall positioning across various strat types,” looks “unstable.”
Remember: A “too low” VIX, or other evidence which ostensibly hints at a lack of concern for a potential drawdown, makes sense (and is rational) if you don’t have anything to hedge. That is, if positioning is bombed out and cash levels are elevated, a lack of demand for downside hedges can be explained by a lack of exposure that needs hedging.
But that explanation doesn’t work when positioning is, on many metrics, stretched. Charlie called recent exposure adds “impulsive.”
Given that, “it makes some sense that the market has finally seen a notable S&P tail-y downside buyer over the past two days,” he wrote, flagging September puts on the S&P, which capture the post-Jackson Hole trade and VIX seasonality.
He went on to emphasize a familiar talking point which I actually reiterated first thing Wednesday morning in “Make Vol Great Again.” “It wouldn’t require a massive move higher in vol to elicit a substantial mechanical deleveraging,” Charlie said.
On Nomura’s measure, vol control’s implied equity allocation sits in the 92%ile on a three-year look back.
He also reminded traders of the “accumulated willingness to short vol” since the Fed and Treasury stepped in to backstop the system in March. That trade, he warned, has been “impossibly smooth,” which “should make you nervous.”
Another spooky contrast – market expecting S&P500 EPS +13% in 2024 while the Fed cuts rates five times.
The algonauts seem to be carrying close to max long positions already. If I read this analysis correctly, investors and hedge funds have followed suit. So, who still needs to buy equities? How much FOMO is left?
What do ya’all think?
I know it has been well-noodled over here previously, but the Fed ON RRP facility, and its propped-up MM fund rates, has simply got to be a factor (in conjunction with the post-Covid excess liquidity surge). The facility has dropped $500B since May, and it’s my default explanation for what has enabled the ongoing run-up. The fact that this facility, which was effectively $0 pre-Covid (at least when it is set beside the literal outline of a mountain that its graph has drawn in 2021-2023), still has $1,770B just waiting to move from “earning 5%” to “actively suppressing volatility for the good of party-goers everywhere” leaves me questioning anybody’s definition of positioning. To me it seems like another man-made asteroid that is in the process of smashing into our formerly well-ordered models of how things worked.
You’re describing RRP transformation. That drain is MMFs moving into T-bills, particularly as the odds of that second Fed hike tipped by the June dots are perceived to be lower in the wake of the June CPI report. MMFs can’t just rotate into stocks, and total MMF assets are still near record highs. So, again, that rotation is into bills. But, it is indirectly good news for risk assets, because the more bill supply that’s absorbed through RRP transformation, the less reserve drain. I’ve gone into a lot of detail on this in some of the Duly Noted articles, including on Wednesday. Here:
https://heisenbergreport.com/2023/07/26/is-it-game-over-for-the-liquidity-drain-bear-case/
https://heisenbergreport.com/2023/07/20/money-fund-assets-loiter-near-highs-rrp-bill-transformation-proceeding-apace/
https://heisenbergreport.com/2023/07/13/money-market-funds-back-to-outflows-rrp-lowest-in-15-months/
I’ve been selling even high-yield long-term investments trying to raise cash. (I’d been buying them as they went down, trying to unload substantially on rallies.) I’m scared of an ’87/’89 type of crash between August and October. Couldn’t agree more.
My guess – for discretionary humans, maybe 1/3 of peak FOMO left.
I’m still long several names using options into early August, has been a nice trade to roll every 2 weeks. I do expect the put skew to normalize a little, this week I opened put calendars to hedge against a 10% decline into the fall, seems to happen every year I don’t think it will be different in 2023, the analysis by McElligot fits nicely with seasonal weakness, traders will start piling into puts at the first real sign of weakness.
Ditto the put calendar hedge against the early fall seasonal decline.