Equity bears are caught in a kind of insanity loop.

Generally speaking, bear cases fall into two categories which can be delineated by way of the (thoroughly exhausted) aviation metaphors macro watchers habitually employ while describing the US economy.

One bear case posits a “hard landing” in which monetary policy’s “long and variable lags” finally catch up to the economy, triggering an abrupt slowdown.

Another bear case posits “no landing,” in which households and corporates, insulated from higher rates courtesy of the historic 2020/2021 refi/term-out opportunity, keep spending and earning, while the labor market continues to add jobs, eventually compelling the Fed to acknowledge a higher neutral rate on the way to turning the screws and forcing a recession in order to vanquish inflation.

The first bear narrative’s frustrated by the vaunted policy “put” which, we learned in March of 2023, absolutely still exists. Jerome Powell’s made it abundantly clear that the Committee considers the risks around its mandate to be more evenly balanced now, which is a euphemistic way of saying the Fed would step in and cut in the event of serious labor market deterioration even if core inflation’s still well above target.

The second bear narrative’s frustrated by the read-through of “no landing” for corporates and corporate profits: A hot economy’s good for business, particularly if you’ve still got some pricing power. Sure, it’d be nice to have rate cuts and robust profit growth, but as long as there’s no chance of rates going higher, investors are ok with a scenario where the Fed’s on hold and corporate profit growth is in the process of inflecting for the better.

“Underlying US economic resiliency and still-full employment = earnings support, particularly from the AI space” and that should “perpetuate the current preference for equities from asset allocators,” Nomura’s Charlie McElligott said Tuesday, explaining why any pullback in stocks and/or any meaningful vol expansion will probably be bought/sold.

That is of course unless the incoming inflation data becomes (or stays, if we’re talking about CPI) problematic, in which case all bets are off.

But assuming relatively benign inflation prints that at least leave two of the three dot plot cuts for 2024 on the table, last week’s “worst fears of another bond selloff,” could fade, McElligott wrote, “which would [put] much of the recent equities hedging… at risk of being lit on fire, where the unwinds could create bunches of index delta to buy and VIX vega for sale.”

That said, it’s worth noting that although the recent uptick in demand for downside hedges (see here and here) doesn’t in itself make a selloff more likely, it does begin to create the conditions which could amplify any downdraft that materializes for fundamental reasons or as a result of some exogenous (e.g., geopolitical) shock.

On the other side of those hedges are dealers — they’re short that downside to clients. In a selloff, their hedging flows could amplify the move. That’s the “selling-begets-selling” dynamic and it should always be considered with systematic positioning/exposure which, as illustrated below, is elevated currently.

When systematics have it dialed up like that, they’re vulnerable to mechanical selling in the event of a sudden downdraft (which pushes spot through key levels) and/or a vol spike (which compels vol-sensitive cohorts to de-leverage).

“Whatever the spot selloff catalyst may be, we would see dealers put into short gamma / short vega positioning, which [would] have them competing with systematics,” McElligott said Tuesday, reminding clients that mechanical de-risking flows from systematic cohorts “act as an additional source of synthetic short gamma” once these so-called “doom loop” flows get going. In other words, it all looks like selling into a hole — “sell[ing] more the lower we hypothetically travel,” as Charlie put it.

To reiterate: That loop needs a catalyst to activate it. You need some kind of vol-expansion shock that gets spot moving meaningfully lower. But coming full circle, we’re still in a kind of “heads bulls win, tails bears lose” situation, where all outcomes somehow lead to an equity bull case.

The first negative NFP print almost surely triggers a rate cut at the very next FOMC meeting. Rate cuts are bullish. Ongoing job gains, on the other hand, point to healthy demand and thereby healthy profits, even if they push the onset of Fed cuts into the back half of the year. Healthy profits make for happy investors and higher stock prices.

Even if we do get a selloff, bears will have to contend with a structural vol supply overhang, which Charlie described Tuesday as “perpetual, mechanical and recurring daily, weekly and monthly” with the effect of  “crush[ing] nascent spot market drawdowns and compress[ing] vol moves.”

Unless you think the US labor market’s going to implode (as opposed to just weaken enough to tempt a Fed Chair who by some accounts is anxious enough to cut rates as it stands), the only way out for bears appears to be meaningful and sustained re-acceleration in the US inflation data.

Now cue another hot CPI release.