dying industry · markets

RBC’s McElligott – Big Picture

OVERNIGHT / MACRO: Chief Risk Officers still in charge of trading books apparently, with DAX and Estoxx -0.9% so far today / SX7E EU Banks -5.5% on week as crowded tactical longs built in recent weeks are purged, NKY -3.1% on the week, CL1 through $45 cleanly to the downside, $/Y under 103 and shorts from Yuan to GBP to USTs being covered in front of next week’s obvious event risk, as the lessons from the Brexit vote (outlined in the “RBC Big Picture” yesterday) are mechanically applied.

greg blotnick - LS equity index.jpg

Rates have gone from “THE” story to complete background, banging-around the gravity of the 1.80 absolute level as leveraged fund shorts are covered into the ‘risk-off’ move of late, but aren’t terribly-squeezed as the overseas real $ demand drivers are largely ‘hand-sitting’ until after the election.  That said, the UST curve steepening has been real of late (2s10s, 2s30s and 5s30s all through their 200dma’s to the upside).  As suchwe see that S&P Financials are the only sector that quarter-to-date is positive at +1.1%.


This lack of a larger more meaningful fixed-income rally against the risk-asset selloff is clearly a negative performance driver for risk-parity funds, while too we can assume that shorter-term ‘vol control’ allocation models continue to drive negative price impact via their stock weightings (sliding allocation / leveraging scale), as spot vol’s grind higher saw a larger ‘grabbier’ move yesterday.  5 day realized SPX vol has traveled from 1.385 last Friday (pre FBI) to yesterday’s closing level at 5.0…for relativity, that’s a not-so-chillaxed +261% move in five sessions.


Despite that fact that nearly every discretionary trader I speak with wants to “buy a Trump sell-off”, it’s painfully ironic that the de-risking driver revolves around this ‘constant re-pricing’ of Trump’s odds higher / tighter.  I laid-out the thought process around trading various election scenarios yesterday so I won’t delve back into that…but I will say that speaking with folks who embedded with polling-dynamics / polling-analytics teams, the recent and profound momentum-swing into Trump from HRC is a force that is exceedingly difficult to stop this close to “go time.”  As such, there is a real belief by many that key bell-weather States of Nevada, Ohio, Iowa and Nevada have tightened / shifted in his favor “real time.”  Add in similar observations in Pennsylvania, and you could suddenly get to the required 270 electoral college votes.  Based on this ‘coin flip’ bringing back the Brexit memories, CRO’s have to take books down aggressively and unemotionally so as to avoid ‘accidents’ come Wednesday….even if the qualitative muscle-memory and intuition tells them that Trump would likely ultimately be a tactical “buy.”


Unfortunately this morning, we have “this” bleeding into the fragile investor psyche on top of already jangled nerves: Sources: U.S. intel warning of possible al-Qaeda attacks in U.S. Monday.”  And worth reiterating from yesterday’s note: on top of the increasing sense that this current US election risk-event overhang will linger for weeks and months to follow, we catch another reminder of “what’s to come” between now and year-end, as just now, we get this headline: Italy Referendum: Yes 38%, No 39%, Undecided 23%: Ixe Pol.”


THE CURRENT INSANITY OF SINGLE-STOCK BEHAVIOR: Apologies to pure macro readers for so much stocks focus of late, but it continues to be accurate to say that all of the action is taking place in equities right now…and stick with me, because there is  some good macro thought-below.  Man was yesterday a bizarre one in US equities….and even stranger, it’s happening in a relative vacuum, as the rest of the macro / cross-asset universe is lulled to sleep with much tighter ranges on the day..


The behavior in equity vol is one thing (as tails were massively bid yesterday—SPX 1m 80% moneyness was +10.2% on the session, while ‘vol of vol’ is now +34 vols / +40.1% over the past 8 sessions)…but the price-action in single-stock was the stuff we haven’t seen since the Q1 market-neutral factor unwinds ripping through the pod-shops…where for a stretch in late Jan / early Feb, teams / books were being blown-out on daily basis around the Street.


Back then, it was ‘bad-positioning’ from the buyside based on macro impact on style factors.  1) Everybody came into January ‘16 long growth & momentum (and thus, “high beta”), aka “story stocks” in tech and discretionary, along with major healthcare sector overweights (biotech / spec pharma / generic drug makers).  Similarly, there was a huge belief in “short bonds” to start the year too–as seemingly the Fed’s long-awaited rate-hiking cycle had just begun the month prior–as such, 2) there was a massive long in financials / banks on expectations of higher rates.  And to put the cherry on top, 3) there was a major quant / stat arb long in energy, anticipating a January ‘mean reversion’ (a tried-and-true back-tested phenomenon).


In hindsight, it is absolute insanity how ‘bad’ that all was—you couldn’t construct it any worse.  As such, the pain trade “went to 11,” as risk-assets were purged under the weight of the deflation scare: China came out of the gates with further Yuan devaluation, crude was -10% on the month, and UST 10Y yields were absolutely obliterated, moving from 2.30 the last day of Dec ’15 to 1.65 by Feb ’16. With all of this, growth and momentum came unglued, the move lower in rates not only crushed bank longs but also too saw a massive rotation into the (dreaded) ‘bond proxies’—‘low vol’ factor, dividend yield, defensive sectors.  You know the rest…


So fast-forward to now: what’s so incredible about the behavior witnessed over the past few days ‘under the hood’ is that relative to all of our recent drawdowns being so clearly macro-driven (deflation / reflation events of the past two years—Yuan deval, crude spasms, Yellen “weak USD policy pivot” / “Shanghai accord,” CB coordinated messaging on “curve steepening” intent, the inflation impulse bond-beatdown etc)…is that this equities move started as simple “de-risking in front of a ‘fluorescent swan’ of a binary US Presidential election”…that has now crescendo’d into a really bad VaR outbreak.


While on the benchmark index level we saw a “barely a paper-cut” 9-handle move in SPX yesterday(-0.4%)…we saw 29 US Composite names with market caps north of $25B dollars which traded -1.5% or (much) greater on the day—heavy-hitters like Kellogg, Apple, AbbVie, Humana, Liberty Global, Intel, Kraft Heinz, Charter Comm, Constellation Brands, HCA Holdings, Starbucks, Target, Anthem, Pfizer, Estee Lauder, Amgen, Lockheed Martin, CVS Health, Kroger (-3.7%), AIG (-4.0%), Allergan (-4.0%), McKesson (-4.6%) and index mega-weight Facebook (5th largest weighting in SPX, -5.6% on day).  Other popular longs like CHD (-6.6%) and THS (-19.5%!) got smoked too, while more idiosyncratic political drama crushed the generic drug maker space, with PUNISHING capitulation in MYL (-7.0%), ENDP (-19.5%) and TEVA (-9.5%) amongst others.


The tech sector has been “THE” hiding place recently for investors, on account of folks getting increasingly nervous about riding their cyclical longs much further here after the run they’ve been on (and crude rolling over sharply -9% on the WTD as the OPEC “deal” looks like anything but)–but also being hyper-cognizant of the inflation base-effect’s lagging-impact on bond prices (higher yields) and purportedly a Fed still committed to a Dec hike (with a steady-state world of course) makes putting back on the ultra-expensive ‘bond proxy’ / ‘low vol’ factor / defensive trade look quite unattractive as well.  So despite tech being such a ‘stud’ recently (XLK +10.2% in Q3), it’s received the ‘rented mule’ treatment as effectively an “ATM” of late (with ‘FANG’ -4.4% over the past 5 sessions, XLK -2.6% over past 5 sessions). 


But maybe the strangest thing experienced was seen amongst seemingly popular and thus theoretically winning short positions, where we saw huge outlier downside moves—BW (-10.3%), FSLR (-15.0%), FIT (-33.6%) and DPLO (-42.1%).  This is simply abnormal.  How do I rationalize this?  Well in ‘max pain trade’ fashion, I think that sadly many had actually given-up on these shorts over the outrageous daily-grind higher period in Q3—remember, SPX was +3.3% on the qtr, Russell 2k was +8.7% and (drumroll please….) the GS Most Shorted Basket was +14.5% on the quarter.  So what we’re seeing this week is that the right ideas that folks once had on in their short books—but were forced to capitulate on during the face-ripping rally in Q3—actually saw their short theses play-out to a tee.  The companies reported terrible quarters, and as such, were promptly hammered and punished / re-deployed by guys who originally had the trade right…but had sadly ‘tapped out!!!’  Just gutting stuff…


Ironically though this time around, we see equity market neutral funds performing very well relatively speaking to long-short or long-only.  take a look at one widely followed quant’s open-end market neutral fund against the HFR Equity Long / Short Index, ‘High HF Concentration basket’ and ‘Mutual Fund Overweights’ baskets over the past two months:


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