Clearly skipping the latest cheerful take from Goldman’s flow traders and instead siding with Morgan Stanley’s increasingly gloomish market views (on Monday, the bank’s chief equity strategist Michael Wilson warned that the Fed’s “turbo taper” will spark chaos over the next 3-4 months), this morning Nomura’s Charlie McElligott writes that both price-action and volumes reek of “trader fatigue” despite a really treacherous week of event-risk (PPI today, Retail Sales tomorrow, Fed policy decision tomorrow, VIXpery tomorrow, Philly Fed and Unemployment Thursday, Quad Witch Friday), which makes sense in-light of “what feels like a rolling 3 month stop-out in both crowded narratives and crowded trades, which has come in conjunction with the Fed’s pivot to “inflation hawks” after dropping their prior “transitory” meme and seemingly embarking on an accelerated policy tightening.“
And speaking of all sorts of crowded trades blowing out, the Nomura quant notes that the factor/thematic pain within US Equities has maintained its torrid quarter-to-date pace so-far into the month of Dec, with the most-pronounced themes continuing to be
- Quality over High Beta / Leverage / Short Interest;
- Cheap Cyclical Value over Expensive Secular Growth; and
- Size / Liquidity Premium—i.e. Mega over Small
And since the above themes have meant significant overlapping pain for many “highly speculative” long-only themes such as the following…
- Wolfe Retail Red Alert Basket -7.0% MTD, -9.1% QTD
- Wolfe Recent IPOs Basket -4.8% MTD, -12.0% QTD
- Wolfe Post-SPAC Merger Basket -7.9% MTD, -14.6% QTD
- Wolfe Non-Operating SPAC Basket -10.4% MTD, -18.0% QTD
… the ongoing pain has has meant a substantial “net-down” of exposure for funds, where over the past 5 days alone with SPX +1.7% and QQQ +1.6%, we’ve seen “crowded longs” sold down meaningfully (the HF Most Crowded basket is -2.1% over the past 5d, Wolfe LT Momentum Longs -3.6% 5d return), at the same time as a persistent and notable pressing of “popular” shorts / shorting baskets:
- Wolfe Fusion Short Basket -1.5% return over the past 5d
- Wolfe Low Earnings Quality Basket -1.6% 5d return
- Wolfe Value Traps Basket -1.7% 5d return
- Wolfe Serial Restructurers Basket -2.2% 5d return
- Wolfe Short Hit List Basket -3.4% 5d return
- Wolfe Highest Short Interest Basket -3.9% 5d return
Besides funds getting stopped-out out popular positions, there is also a spike in a substantial “Tax Loss” selling dynamic, where as McElligott notes, historically the peak of “tax loss selling” season is 11/1 through mid-De, as evidenced by the Wolfe “Potential Tax Loss Selling Basket” -13.9% over that period, underperforming SPX (+1.4% since 11/1) by 15.3%; underperforming QQQ (+1.6% since 11/1) by 15.5%; and underperforming IWM (-5.3% since 11/1) by 8.6%
* * *
There is some good news for the bulls: according to research from Chris Senyek/Wolfe Research over the past 15 years, the optimal time to put on a “rebalancing trade” to reverse said “Tax Loss harvesting” flow is NOW from Dec 15th through Feb 15th, where the bottom decile of SMID Cap Stocks has returned 1100bps on average over that window since 2006, producing positive returns 88% of the time and outperforming Russell 2000 94% of the time.
There is more good news for bulls when one turns attention US Equities index options, and especially Greeks positioning into the upcoming massive Op-Ex, which according to Goldman sees some $4.3 trillion in contracts expiring…
… Nomura sees a set-up to move “bigly” with some chunky Gamma dropping-off and serious “long Delta risk” in SPX / SPY and QQQ, versus “short Delta risk” in IWM.
- First, the SPX/SPY $Gamma drop-off is substantial enough, with 33.7% of the $2.2B positive $Gamma (34.9%ile) coming-off…but it’s the “long Delta” that is the market risk, with $434.4B (95.6%ile) and 55% of that Delta rolling-off—big strikes 4750, 4800 and 4700
- Second, QQQ is “gonna get weird”, because we currently expect to see 61.8% of Gamma to roll-off (it is extremely negative right now at -$551.6mm / just 2.6%ile), with $6.8B of long risk with $Delta (80.9%ile) and 60% of it estimated to drop — 400 is the largest strike, followed by 390 and 385 in-play
- Finally, IWM will see 53.8% of its extreme negative gamma drop-off (-$484.4mm at 1.8%ile), while extreme short delta (-$13.9B, also 1.8%ile) will see 44% of that coming-off as well—220 is the largest strike, but spot is currently at the 2nd largest Gamma strike of 215, with 210 strike also in-play
Looking across assets, the Nomura quant warns that fixed-income has been and remains a morgue, and looks to stay that way into January (absent of an inflation surprise in either direction), with the market consensus “locked” on an accelerated (doubled) Taper to complete March which gives the Fed enhanced “optionality” on hiking in ‘22, coalescing around June as “liftoff” for hikes and ~8 dots in agg btwn ’22 – ’24 (or as Mcelligott puts it best “lol yeah right”)
Shifting to the front-end, it’s far more nuanced when looking at Eurodollar curves and various rare “inversions” however: indeed, as discussed previously, front-end Eurodollars continues to anticipate a rather “hawkish” set of initial hikes, but the long-end Eurodollars showing potential for policy reversal soon thereafter—i.e. Fed hands being tied and tightening now into this inflation overshoot, but during an already maturing / “slowing” economic cycle…which indicates a “short” policy tightening cycle at the very least, or worse, a potential “policy mistake” which will subsequently need-be unwound with Fed easing shortly thereafter.
This scenario would align with Nomura’s recent “Economic Quadrant” work, which showed the US economy having recently transitioned into the current “Slowdown” phase (from prior “Expansion”) now over two months ago…
… but would likely see the final economic cycle “phase shift” into outright “Contraction” coming in mid- / late- 2022…and where the forward-returns tend to notably “rhyme” with the recent price-action. Incidentally, here again is which stocks perform best
The last question, as we asked on twitter last night, is now that the slowdown in both the global economy and M2 are fully evident to those who pay attention, and the time has come to start thinking what central banks will do on the other side of this reflationary/slowdown episode, just how big will the next monetary stimulus be (and what trigger will be used to enable it), and when.
The red arrow is priced in. The only question is how big the green arrow will be and what will trigger the surge. pic.twitter.com/m5Q6KaiP1n
— zerohedge (@zerohedge) December 14, 2021
