A week ago (maybe two, I can’t remember), one reader suggested that tracking vol dynamics wasn’t worth the trouble and that the same goes for positioning across fundamental/discretionary investor cohorts and systematics.

I did that reader a favor: I didn’t publish his/her comment. If I’d been in a bad mood that day, I might’ve published it and then simply asked, “Well then what, exactly, should one track?”

As we saw in 2023, trying to forecast asset prices based on what I’ll generously call macro-fundamental considerations (the ungenerous description would be “Our economics team’s forecasts, our top-down EPS models and the assumption that past is everywhere and always precedent”) is risky, and likely to become more so as global affairs and domestic politics get more complicated.

More useful over near- and even medium-term horizons are flows and positioning. I come back, again and again, to an October 30 note penned by Nomura’s Charlie McElligott, who suggested cheap upside exposure given the positioning purge and broad-based de-risking that played out alongside the August-October Treasury selloff. As I put it at the time, “right-tail risk is often underappreciated.”

Over the next two months, equities and assets of all sorts surged in one of the more dramatic cross-asset “everything” rallies in recent memory. The index rally caught everyone flat-footed, which is to say under-exposed, and covering from CTAs in rates and bonds facilitated a rally of truly epic proportions which naturally spilled over into equities.

On Wednesday, in his first note of the new year, McElligott described an “end-of-year ’23 equities ‘book-up’ to chase the rally that nobody had enough net exposure for.” It played out “in violent and swift fashion,” he went on, “all boosted by generational premium income / VRP / QIS vol supply to further turn the screws via systematic vol control reallocation flows and CTA trend flipping ‘short-to-long’ across global equities.”

The figures above illustrate the point. That’s why you have to stay apprised. If you don’t, and instead rely exclusively on this week’s edition of the same top-down, research-side fundamental bear case you’ve been reading every week for six months, well… thoughts and prayers. And don’t be surprised when you miss a melt-up.

In any event, McElligott was adamant during November and December that a selloff wasn’t likely into year-end despite the escalating scope of the rally. He was right.

So, what now? Well, “like all good things, gains from forced re-positioning of nets and grabbing into beta now need to adjust,” Charlie said Wednesday. “Accordingly, we are seeing a modest index-level consolidation to start the year.”

Everyone (not literally, but you know what I mean) chased the index rally into year-end (i.e., grabbed for beta), but now, with “the fresh risk / PNL calendar, folks are beginning to shift back into more tradition ‘active,’ idiosyncratic, single-name risk,” McElligott wrote.

Ultimately, though, Charlie suggested the odds of a big fireworks show are relatively low, and that January is likely to see more vol supply, which in turn means a market that’s insulated from big swings. “There’s just so much product looking to sell optionality into any nascent vol squeeze higher,” he wrote.

Regular readers will recall that McElligott repeatedly cited flat skew as a sign that a big downdraft was unlikely. He revisited that on Wednesday.

“You’re simply not gonna get conditions for an equities crash-down until you get extremely high skew again,” he reiterated. “You need people to be ‘forced-in’ long enough to necessitate hedge demand — i.e. willing to spend premium because you’re getting positive enough returns from your underlying longs that you actually have something to hedge.”

As the figure shows, there’s some movement, but it’s not sufficient. “SPX skew is trying, but not there yet,” as Charlie put it.

He also said the 100 level on VVIX (vol-of-vol) is worth watching for “evidence [of] hedging indigestion challenges” for dealers amid any additional uptick in vol.