On Monday, we reported that “having correctly predicted the post-October market rout, over the past month Nomura’s cross-asset strategist Charlie McElligott has been calling for what one could call an imminent bear market rally. And in the two weeks since Christmas, he got just that, writing in a note this morning that “this is the exact tactical rally I’ve been anticipating on a run back towards 2600+.”
So with stocks already running an impressive 5% higher since last Friday’s Powell speech/payrolls/RRR cut, and nearly 10% since the Mnuchin Massacre on December 24 when the Treasury Secretary decided to invoke the Plunge Protection Team during his Cabo vacation, is this tactical rally almost over?
Not according to the man who called it in the first place, because as McElligott writes in his latest note to clients this morning, while “there will be a time to fade this Equities move with a tactical “short”/a structural move “up-in-quality” based-around the end-of-cycle “tighter financial conditions” realities (with a power-steepening of the UST yield curve likely acting as one signal), along-with the still-maintained QT-pace”, that time is not now, and instead “right now you have to keep running the tactical “long” I’ve advocated since end-Dec ahead of the below macro catalysts and flows—especially with 1) the approaching earnings season- and 2) contrarian “negative earnings revision”- bullish catalysts PLUS 3) resumption of buyback flows after the first week of Feb in your back pocket.”
As McElligott further elaborates, the reasons why risk is again “foaming at the mouth in grabby fashion” are five-fold, and include:
- dovish Fed inflection/evolution continuing to develop (into HEAVY Fed speaking calendar this week),
- more aggressive Chinese / PBoC easing & stimulus actions,
- bullish US/China trade negotiations “leakage”
- widespread under-positioning in Equities which will be “forced-in” after missing this Beta-led rally (S&P futures +11.5% / Russell futures +14.5% off late Dec lows) with potential additional “upside kickers” from the Systematic Trend- and Vol- communities; and finally, as laid-out yesterday,
- the bullish Equities / bearish Rates catalyst of again climbing inflation expectations—largely via Crude’s reacceleration +20% (!!!) since Christmas Eve lows
Of these, while we have covered 1, 2, 3 and 5, it is #4 that may be of most interest to readers and traders, especially since McElligott once again – controversially – lays out the key trigger “buy-in” points for the “algos”, i.e. CTAs, who in mirror image action from December will soon be forced to switch from “Max Short” to net long, and be “forced-in” to buy risk, the higher the market levitates.
This is the result of the previously discussed widespread “Under-Positioning” in Equities – and a resulting “Force-In” – dictating potential “Reversal Flows” within the systematic community, which would bullishly impact broad “Risk-Assets.” McElligott explains:
I’ve previously highlighted numerous metrics communicating the scale of the Equities de-risking which had occurred and accelerated throughout 4Q18—but now there are two significant flows which could drive large notional COVERING in Equities via the current “Max Short” positioning in Global Equities from the CTA / Trend universe, as well as the potential return of “mechanical” VOL SELLING flows from Systematic “roll-down” strategies.
The punchline: while CTAs currently remain positioned “Max Short” in the majority of Global Equities futures (Spooz, Russell, Nasdaq 100, Nikkei, HSCEI, KOSPI all -100%), McElligott notes that “we are increasingly nearing COVER levels with significant $ to BUY; and some of this covering is already indicated by the Nomura CTA Model, showing a meaningful reduction in the scale of the shorts yesterday for Eurostoxx, DAX, FTSE, CAC, Hang Seng and ASX–all now reduced to just -80% Short.”
A visual summary of Nomura’s “covering/buy triggers” model is shown below: it notes, for example, that CTAs will start aggressively buying about 50 points higher, or when the S&P hits 2,632, with comparable levels for the Russell and Nasdaq at 1,4441 and 6,695.
It’s not just CTAs reversing bullishly that is the next technical catalyst.
As Nomura adds, “if we do get this Equities “gap,” we would then expect the Equities Vol surface to re-price, and this is significant as a 2nd derivative catalyst going-forward—because Systemic Vol funds who play UXA “roll-down” have been MECHANICAL BUYERS OF VOL since the curve first kinked / inverted three + months ago.“
This matters because “if we finally see this jump move higher for Stocks and the VIX curve then normalizes “upwardly-sloping” again, we will then see this “Long Vol” stance unemotionally pivot back to SHORT VEGA, per their models.“
This matters not just for “bullish” optics, but quantitatively / fundamentally too, as VIX (a proxy for generic “risk aversion”) is a top three macro factor price-sensitivity across the current asset spectrum per the Quant Insight model—registering as a top price-driver in 10Y BTPs (Sovy risk), SPX/ NDX /SXXP / NKY/ MXEF / HSCEI (Equities risk), EURJPY (FX risk) and JNK (Credit risk)
And visually, here is the current macro factor landscape showing the importance of the VIX, i.e., “risk-aversion” for asset levels. In other words, the higher stocks rise, the more buying pressure will emerge as the VIX risk factor fades away, if only for the time being.