In “Canaries And Key Levels” and also in “Stocks Look Beyond GDP Barnburner To Price Slower Growth,” I spent some time editorializing around the juxtaposition between ebullient US macro data and the bad vibes from the equity market.

It’s not just that the S&P and Nasdaq 100 have corrected. Indeed, that’s not the story at all, although corrections for the benchmarks make for good headlines. The story is stumbling small-caps. The story is ominous underperformance for cyclicals. The story is poor breadth. The story, as Nomura’s Charlie McElligott wrote Monday, is a “credit cycle downturn theme” predicated on the read-through of tighter financial conditions from the three-month (and also three-year) selloff in US Treasurys.

That theme is manifesting in (“dictating,” as Charlie put it) a powerful up-in-quality trade, with strong balance sheet, low-beta, high cash flow, highly liquid mega-caps benefiting while poor balance sheet, credit- and economically-sensitive names suffer.

The Russell 2000 is the poster child. It captures a lot of risk factors, including a very steep maturity wall. A number of Nomura baskets with similar characteristics have underperformed egregiously since early August, when the latest leg of what’s shaping up to be the greatest bond bear market in six decades began.

The FCI tightening, along with geopolitical jitters, have now prompted investors to cut nets and move into cash, McElligott said. Nowhere’s safe. The mega-caps are under siege from the inexorable rise in yields, and decent earnings weren’t enough to rekindle the Magnificent 7 euphoria.

Investors, Charlie went on, are “look[ing] to monetize rare winners in light of the already extremely challenged YTD performance dynamic for equities where just seven stocks were the entirety of index gains.” That monetization is “finally leaning on broad Index, as the market began to ‘shoot the generals.'” Fortunately, short books have fared well, a saving grace for some funds.

So, where to from here? Well, anytime you get a positioning purge or even just a broad-based de-risking, any subsequent rally hurts because everyone’s underexposed — “nobody has it on,” so to speak.

The figures above give you a sense of things. Asset managers have cut positioning by more than $60 billion over three months, according to CFTC data, while vol control de-allocated to the tune of $54 billion and CTAs sold more than $21 billion, on Nomura’s estimates.

“So the concern here is that we have exhausted selling, both systematic and fundamental, while downside hedges too are deep in-the-money and at risk of being taken-down and monetized, which could set off some ‘reversal flow,'” McElligott wrote, on the way to describing the sequencing for a prospective Santa rally via a familiar feedback loop:

If we get 1) a big ‘puts monetized’ theme, 2) vols bleed further from ‘rich’ current iVol levels, then there’s 3) $Delta to buy as hedges get unwound, and from there, you have 4) potential waves of synthetic short gamma as funds, both active and systematic, become the dreaded ‘buyers higher’ and have to add-back exposure the more we rally.

Again, that’s all hypothetical. Positioning could be cut further, the bond selloff could escalate, the data could turn decisively such that bad news is too bad to be “good” (“bad news can’t be good news for long,” as Goldman’s David Kostin put it last week) and on and on. You know the left-tail risks.

But, as we’re reminded whenever there’s a melt-up, right-tail risk is often underappreciated. Just ask anyone who was forced to grab for upside exposure in June and July.