“The volatility ‘tail’ is once again wagging the US equities ‘dog’,” warns Nomura’s Charlie McElligott adding that US equities behavior is super idiosyncratic right now.
There is of course this fundamental “earnings- / revenue- growth” case which has continue to power the Tech sector (and with it, the performance of “Momentum” factor), which especially in light of its enormous buyside overweight / index weight, huge overseas cash and thus, potential for MASSIVE buyback upgrade potential, has made it the hands-down “winner” YTD, despite the larger rates selloff and reflationary environment seemingly creating an environment where historically, “cyclicals” and “value” would expect to benefit.
Obviously from a macro perspective, we have made the case that SPX regime is now being driven by the “financial conditions” theme – with the largest price-sensitivities now being shown as interest rate volatility, real yields, credit spreads and USD liquidity. As such, you can pretty-much determine the direction of Spooz on most-days based upon whether “real yields” are higher or lower. The Quant-Insight model shows us that the R-Square of said SPX regime is at 85%, near the highs of the last year and meaning prices are highly explainable based upon these factors.
But without question, the ongoing “reset” within the volatility space post the early February “shakeout” of VIX ETPs and broad “short vol” / “negative convexity” strategies continues to cause impact. Namely, it is the now “missing” SUPPLY of vega that had been a daily-feature into the close from the leveraged short vol ETN products that is having a real impact in driving this “higher floor” for equities volatility. And as this has “reset,” it is reverberating out into systematic model-driven strategies which have been built and grown very popular / success IN THE OLD REGIME. One example would be “roll-down” strategies, which use short-term models based off of VIX futures term structure.
Following February’s blow-up in VIX space, the curve has been inverted effectively all month, and as such, many of these strats have been “long vega.” Last week however, the calming / V-shaped rally in SPX saw the curve resume its upward-sloping shape, and many models again turned “short vega” once again – which was very likely the reason that last Friday afternoon the SPX saw that late-day melt-up, as dealers were caught synthetically short SPX delta as vols were hammered and the curve steepened.
This week however, a speculated massive OTC buyer of SPX puts – potentially in-conjunction with the ongoing reset of the equities macro-regime to one being based-upon a pivot towards “financial conditions” and in conjunction with Powell’s “hawkish” messaging in his testimony – again caused a “kink” in the front-end of VIX futures term-structure. In turn, the recent flip to “short vega” was basically caught-offsides and forced to cover as the curve against inverted.
We now see VIX back trading around / above the 20 level, with front-month UXH8 +16% over the past three days, while stock intraday volatility remains in an entirely separate universe from the 2017 regime, with “carry” strategies realizing there is no free lunch in the new world order.
Additionally, McElligott noted intraday today that “these systematic vol rolldown guys have been NUKED by the huge RP fund thats been buying all this spx downside this week…vix term structure went inverted to upward sloping and inverted again in 4 days. “
EQUITIES / CREDIT SECTOR RAMIFICATIONS:
The set-up then gets pretty interesting as it pertains to just how underweight / short funds are of the ‘defensives,’ ‘bond-proxies,’ ‘low-volatility proxies’ and / or ‘rates sensitives’ spaces – i.e. REITS, Telcos, Utes and Staples spaces which make up 4 of the worst five S&P sectors YTD. On the flip-side, major “growth” plays in Semiconductors and Biotech should then be watched as spaces that are crowded which could be ripe for a tipping on larger selloff.
MOMENTUM BEING LOST:
The danger now of a “strained market psyche” comes back into play, with funds scrambling to chase the recovery of the past few weeks via taking-up NET EXPOSURE. Now that by-and-large shorts haven’t been added, this sell-off will feel worse. And to this point on “waning sentiment,” we see SPX, EEM and IWM all through 50dma; FXI (China) through both 50 and 100dma; Bloomberg Commodities Index through 50dma; and EURUSD through its 50dma.