Nomura: “What Was That?”

Submitted by Charlie McElligott, managing director in cross-asset strategy at Nomura

Today’s talking-point is the buy-side head-scratching on widespread ‘minor but curious’ performance wobbles experienced yesterday, as numerous consensual trades (largely concentraded in equities though) reversed course and disrupted the placid ‘momentum’ / ‘carry’ market of the past month +(basically everywhere but credit markets, where despite paper and duration risk, stuff traded ‘just fine’).  Here are my thoughts:

WHAT WAS THAT?: Many have asked if there was an obvious impetus behind yesterday’s ‘wonky’ moves in everything from equities themes to crowded momentum and macro trades.  Four thoughts–two macro, one market structure, one positioning-related:

  • Perhaps it was the ‘gap down’ in rates (Sunday overnight) ahead of US trader arrival Monday morning, as the new incremental sellers of USTs from the MBS space (convexity) hedging and its concurrent options dealer (short gamma) hedging spooked the market again with yields to multi-year highs.  Concern that the ‘too much rate vol’ transitions the environment from the ‘slow-and-steady’ repricing growth and inflation ‘goldilocks’ state, to instead, one where suddenly folks are worrying about “financial conditions tightening faster than we’re growing,” which has been a phrase I’ve been using since early last year to characterize ‘smart’ macro views on the “when the rates move is too much” concerns.
  • Perhaps, too, from a ‘butterfly flapping its wings’ perspective, is what I mentioned in yesterday morning’s ‘Nomura Cross-Asset’ note: the US Dollar as a ‘pain trade reversal risk,’ after seeing only modest squeeze on the day, yet clearly having an outsized impact on numerous popular trades on the ‘other side. Long equities momentum / high beta, long crude, long euro (fx) all went ‘wrong-way,’ many of which have the ‘weak USD’ at core of thesis. 
  • Without a doubt too—as evidenced in a deeper-dive on equity vols (below) and from that cross-asset ‘vol snapshot’ jump above—the universal theme of ‘a world short volatility’ due to central bank mon pol and asset purchases and market structure / the growth of ‘negative convexity’ strategies was a contributing factor to yesterday’s move.  For instance, see the scale of VIX ETN positioning at the bottom of today’s note.
  • Finally isclear signs of ‘investor herding’—whether it be RSIs across macro ETFs (high and low), cross-asset CTA positioning (see one-liner in red below) and insane performance of US equities ‘momentum’ factor longs (1m performance is the 89th percentile since 1995).  The more crowded, the more prone to ‘tipping.’

YESTERDAY’S THEMATIC EQUITIES WOBBLE: First ‘down day’ in a long-while on the equity HF side.  By the end of the day I had received countless inquiries, generally (paraphrasing) to the tune of “U get impression a lot of hf’s hurting today?”

The answer is…well, kinda.  That famous “99-day streak without a drop of 60bps in the S&P” market meme that was getting sent around the Street early Monday morning?  Yes, it was finally broken by the cash close.  Hilariously, the miniscule final -67bps move in the SPX on the day was a -1.8 z-score move over the returns of the past year. 

And that’s part of the ‘relativity’ problem: there just haven’t been many ‘bad days’ of late, so any little wobble ‘feels’ a lot worse than you’d expect it to, especially considering the leverage currently deployed in said ‘momentum’ and ‘carry’ market (any questions on that, I’d refer you back to the CTA / Trend positioning data sent in yesterday’s note—quick summary: 100 ‘max long’ in effectively all major global liquid equities futs (ex ASX); max longs in Oil (Brent and WTI); max long in Gold and Industrial Metals; max long in all G10 FX vs (short) USD; max short US Rates (TY and ED4)).

From the thematic equities-perspective, there was clearly some unwinding of momentum winners (i.e. Tech / Semis), in addition recent ‘renter cyclical longs’ in Energy / Inflation & Materials / MLP -spaces.  Again, in absolute terms, the actual drawdowns were obviously modest.  But the breadth of the ‘bleed’ was pretty wild, as it’s clear there were PNL reverberations which ‘shook off’ what has been a YTD slumber.

Check this out:

  • Yesterday was the 2nd worst day YTD in my equity L/S HF model
  • The worst day in ‘crowded hedge fund longs’ basket since December 4th
  • The worst day for ‘mutual fund overweights’ since December 4th
  • The worst day for ‘1Y price momentum’ factor longs since December 4th
  • The worst day for ‘1m price momentum’ factor longs since December 4th as well
  • The worst day in ‘S&P Energy’ sector since July 5th
  • The worst day in ‘revenue growers’ since December 4th
  • The worst day for the ‘deregulation beneficiaries’ basket since November 7th
  • The worst day for ‘Trump tax beneficiaries’ since September 5th
  • The worst day for ‘cyclical beta’ thematic longs since September 5th
  • The worst day for ‘USA Min Vol’ and ‘USA Low Vol’ ETFs since August 17th  
  • The worst day for ‘strong balance sheet’ longs since August 17th
  • The worst day for ‘Capex / Sales’ factor longs since July 6th
  • The worst day for ‘inflation longs’ basket since September 5th
  • The worst day for ‘MLP Total Return’ index since October 25th
  • The worst day for ‘high Sharpe ratio’ basket since October 25th
  • The worst day for ‘1m Value’ factor shorts since October 25th
  • The worst day in ‘ROE’ factor longs since October 30th

To also be fair, we are dealing with this move off the back of the crazy Friday move, and into potential rebalancing flow with January month-end.  Noisy, indeed.

VOLATILITY AWAKENS AHEAD OF EARNINGS, BUT CROWDING AND ‘SHORT VOL’ OFF A LOW-BASE TO BLAME AS WELL: But the larger story to me yesterday was the move in SPX implied vols, ESPECIALLY focused in the CROWDED large cap Tech / Cons Disc / Healthcare spaces, with key names reporting in the next week +.  An uptick in vols ahead of earnings should be expected of course…but off such a low base (too low), it felt ‘thunderous.’ 

The VIX outperformance was so large relative to the S&P move that we would have expected SPX closer to the 2805 level.

 

Regardless, the outsized vol move (and its impact on the VIX future) forced a rebalancing from the exchange traded notes universe to the scale of $ 3B of SPX futures delta for sale // equivalent of 46k VIX futs to buy.  Remember: the current scale of the vol short (outright) sits near all-time highs, while the NET vol short IS at all-time highs.

 

 

 

So the stock story was / is three fold: 1) crowded positioning in key large cap sectors with a 2) concentrated earnings window, against 3) all-time highs in ‘short vol’ positioning. 

Good news is that US corporate stock buybacks should ‘kick back in’ next week, with 75% of the S&P having reported by Feb 4th—meaning they are no longer in the ‘blackout’ period.  Fins make up 23% of the buyback; Tech, 22%; Cons Discret 17% and HC 11%. 

That type of flow is what will immediately (next wk) stabilize index and reset vols lower, again.

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