Equities headed into the back half of December riding a seven-week melt-up.

That alone is enough to suggest stocks are due for a breather. Seven weeks is a long time, after all. Almost two months I’m told. If you’re a dog, and you’re less than one in human years, the current equity rally is more than two years old on your time.

So, it wouldn’t be terribly surprising if the Santa rally stalled this week ahead of Santa’s annual world tour. Or next week, when Americans will make all kinds of promises (adopt “resolutions”) about what they will and won’t do in the new year, only to break them (all of them) within the new calendar’s first month.

Who knows, though. There’s not a lot of utility in standing in front of the rally train right now and that’s anyway beside the point: Exactly nobody who matters will go out on a limb with two weeks left in the year.

So, it’s really about January, and that’s when things could get interesting. I talked at length last week about the notion that some of the $6 trillion parked in money market funds might be enticed off the sidelines to chase equities. But aside from that, there’s the simple fact that it’ll be a new year and a chance for anyone caught offside (i.e., under-positioned) by Q4’s melt-up to play offense against a backdrop of diminished monetary policy risk.

“Fresh optimism and fresh money into a new calendar year of PNL could easily incentivize ‘chase-y’ behavior, with grabbing into upside vol on the breakout to all-time highs,” Nomura’s Charlie McElligott said, adding that “a provocative gap up in equities index to start 2024 is especially rational with the way this equities tape got away from everybody since October.”

There are two ways an early-year melt-up extension could be destabilizing. The first is through the money market fund channel, whereby the hypothetical drain of MMF AUM to fund equities FOMO removes the liquidity cushion that was so critical systemically in 2023. The second is through the all-too-familiar “crash-up into crash-down” sequencing.

For weeks I contended that low vol could be explained in part by a lack of demand for downside hedges, which in turn suggested crash risk was overstated. The other side of that would be a melt-up in the new year that sees positioning and leverage extend. With that in mind, the short excerpt below from McElligott succinctly captures how the market could go from a “safe” grind higher (characterized by under-positioning and flat skew) to a perilous, all-in melt-up vulnerable to “elevator down” in the event an exogenous catalyst shocked spot equities lower, activating so-called accelerant flows from dealers on the other side of the hedges protecting investors’ rebuilt longs. To wit, from Charlie:

In order to get crash down conditions, you also need excess positioning / leverage, because when investors are back running ‘extreme long’ exposures, they are also forced back into buying actual downside hedges. This would mean index options skew ultimately then steepens out again. You can’t crash down with flat equities index option skew. [You] need steep skew which, again, requires [a] ‘force-in’ to extreme equities positioning. When investors need to hedge big long exposures, they take dealers on downside, which means dealer hedging then risks turning into ‘accelerant flows’ which feed moves / overshoots instead of insulating [markets]. On a spot selloff catalyst [under those conditions], dealers who are short index downside are then getting short vega / short gamma into a move lower, as vols then squeeze higher.