The equities right-tail (i.e., crash-up risk) was back in play on Wall Street, where US stocks looked poised for new all-time highs to start August.
In terms of fundamental catalysts, robust earnings and, more immediately, optimism around a deal to re-open the Strait of Hormuz were the most obvious bullish tailwinds.
Brent was back below $80 on Tuesday, helpful for a jittery USD rates complex that scarcely needed another irritant following last week’s FOMC-inspired tumult.
But the interesting wrinkle in what might be a burgeoning equities force-in is the extent to which the long-short extremes observed in the lead-up to Leopold’s momentum unwind (known derisively on finance-focused social media as “baby’s first margin call”) ironically helped set the stage.
“Perversely, we got here off the back of the past 4-6 weeks’ pain,” Nomura’s Charlie McElligott wrote Tuesday, reminding investors that the main “problem” with the consensus trade that was long AI-enablers and semi “bottleneck” plays versus short cash-burning hyper-scalers, was that the latter’s weight at the index level meant “broad equities couldn’t make new highs.”
“The hyper-scaler, mega-cap, Mag8+ names had been relegated to ‘funders’ status, hence the sideways-to-down ‘chop’ in spot index for [most] of the past three months,” McElligott said, adding that since late-June, sundry manifestations of that same market-neutral trade have been absolutely destroyed. On the reversal, the hyper-scalers rallied sharply, which is what ultimately matters for “stocks” as a cap-weighted asset class.
The figures above give you a sense of things. In the same note, Charlie cited an even more poignant example of the reversal: A variant of the same trade that was long DRAM plays and short Mag10 names is down more than 33% in five or so weeks.
“[A]s those prior dynamics got rinsed in a biblical momentum unwind,” equities index quietly rallied 4% on the back of the hyper-scaler recovery, McElligott went on. Now, everyone’s “chasing back in [and] netting-up as we rally back into long-forgotten calls.”
Have a look at the hilarious figures below, which McElligott went out of his way to highlight in a second Tuesday note.
Suffice to say the left-tail’s suddenly dead and the right-tail’s Lazarus on biker speed.
“Calls are now picking up alllllll the delta,” Charlie said. “There’s bunches of real and synthetic negative gamma out there and [the] market’s forced to front-run it without enough net on.”
Don’t worry about Leopold. The “Pretzel Magnate” will be back on his feet in no time.
As for the markets, it looks like they are sucking-up helium over there on Wall Street once again. If I owned those high-fliers I would be taking some profits right now, or very soon, but I am more conservative than most. Does it concern anyone else that the KOSPI has fallen (crashed?), and Japan and the U.S. are defending the yen, yet our markets are still climbing?
You’ve published two good pieces on the underpinnings of the rally. Which is more important? Earnings or algos?
Or, how much money do each drive in the short term? Which is all that matters in my humble opinion.
out passive inflows?? Can you convincingly argue that they are earnings-driven?
Pondering this a little — where do the largest inflows come from? #1 are buy-backs. You could argue that they are somewhat earnings-driving. (Somewhat clouded by borrowing to fund buybacks.) Followed by all of the algo models. Some may have earnings as one input in their models, but most do not. How ab
So that leaves long-term investors (who are not hopping in & out of the market on a daily basis). Then we are left with speculators, large and small. Outside of traders reacting to earnings “misses and beats” for a few days after they are released, how many really buy or sell based on earnings? Certainly not the hordes waving in OTDE options, Rediteers/Roaring Kitty kind of traders. Long-short specs do look at earnings when choosing pairs, so you got them.
All-in-all, do earnings really matter in the short and medium-terms?
Correcting:
Pondering this a little — where do the largest inflows come from? #1 are buy-backs. You could argue that they are somewhat earnings-driving. (Somewhat clouded by borrowing to fund buybacks.) Followed by all of the algo models. Some may have earnings as one input in their models, but most do not. How about out passive inflows?? Can you convincingly argue that they are earnings-driven?
So that leaves long-term investors (who are not hopping in & out of the market on a daily basis). Then we are left with speculators, large and small. Outside of traders reacting to earnings “misses and beats” for a few days after they are released, how many really buy or sell based on earnings? Certainly not the hordes waving in OTDE options, Rediteers/Roaring Kitty kind of traders. Long-short specs do look at earnings when choosing pairs, so you got them looking at earnings.
All-in-all, do earnings really matter in the short and medium-terms?
It seems like “algos” first and foremost identify a stock that has strong underlying fundamentals that lead to upward growth/profitability – and therefore, long term upward pressure on stock prices.
Then, the algos (collectively?), on a short term basis, manipulate the short term and insecure investors into trading based on “news” that is likely being controlled/ written by the very same algos or “swings” started by significant capital in hedge funds attached to the very same algos.
This is all “noise”. I still believe that in the long term, what matters most is the same things that have always mattered: buying a well run company in an industry with long term growth and profitability potential. Then, just have the confidence to hold through all the noise.
GLTA.
I believe that you are thinking of people who use screens to identify shares that match your valuation, growth, payout and other goals. AI may speed that up.
I was referring to the traditional momentum/trend-following traders who have been augmented by the newer cohort of algos which only key off of volatility. We owe thanks to our Dear Leader for covering this way before the mainstream financial writers were even aware of it. Politics and earnings do not matter to these. They’re all strictly based on price movement.
At the moment, the old Dodd-Graham theories are less effective, partly because they were developed long before most of these actors roamed the earth. But investment styles are not static so earnings-focused strategies may well start to drive things again. Some day.
Remember: The negative gamma effect here isn’t really “algos,” per se. It’s market-maker hedging flows (“real”) and leveraged ETFs (“synthetic,” as Charlie puts it). The much-maligned “robots” — e.g., CTAs and sundry manifestations of target vol — can and do play a key role, but there’s a distinction between, on one hand, MMs having to buy strength / sell in the hole to stay hedged + the levered ETF EOD rebal flows and, on the other, “algos” in the sense you guys/gals mean it. (Obviously a lot of market-making is algorithmic now, but I don’t think that’s the point anyone’s making here.)
Good point, sir.
But a walk down memory lane — was it just a year ago when you, McElliogot and Rubner were talking about how sellers of volatility were swamping MM books and pinning the underlying market around the major strike prices?
Ah, I do hate it when things change! As they have when “risk-parity strategies were one of the largest algo players.