Failing to take advantage of positive dealer gamma, the S&P is now stuck in “no man’s land” and as Nomura’s Charlie McElligott writes in his latest note, the market is “essentially near the Dealer “Neutral Gamma” level (~2845) and between 2 of the 3 largest Gamma strikes on the board (2850 w $1.355B and 2900 with $1.284B), while also now at the “Neutral Delta” level (2882 incl this week’s expiry).”
Separately, after CTAs briefly flipped to 100% positive, Nomura’s CTA model positioning in the S&P is quite small currently (signal is back “-69% Short,” but only a 4% gross-allocation across the aggregate portfolio), at low gross exposures levels due to the recent signal chopping back-and-forth. CTAs are also somewhat distant from buy- / sell- triggers in either direction, with the next sell level is down at 2746 in order to go to back to -100%, while the nearest buy level is 2936 to go all the way back to +100%.
So with little technical push on either side of spot SPX, what happens next?
According to Nomura’s McElligott the rally is now done, at least for the next few months, and as the Nomura strategist writes, “his sense is ‘lower’ for the next move in Spooz across the Summer months, as I think the market’s current pragmatism towards the virus in conjunction with the “feel-good” of the rally leaving it exposed to the downside of a coming second-wave as cases, as restrictions ease and some States rush back to “normalcy”…yet with fewer Fed and fiscal bullets in the chamber next time around.”
Another reason why the ramp is ending is that, as noted above, CTAs are now “somewhat distant from next triggers” and as a result “we are running out steam on the systematic vol-control-type re-leveraging at “status quo,” where in order to make the $allocation to Equities grow again significantly, we would need to see 3m realized vol (~60) fall below 1m realized (~40)—and that would require a significant “impulse” move requiring a new catalyst—so not necessarily a “sell” catalyst, but speaks to a potential “demand” vacuum.”
He then looks as the historically “weak-ish” thematic Summer seasonality for Stocks (Sell in May) and risk-sentiment (where Gold and USTs trade strong, while May thru Sep is bad for EEM and US Equities themes see Duration Sensitive Equities / Mo Longs tend to strongly outperform vs Cyclicals / Mo Shorts) matters into this current “directionless” trade
For some perspective, here is what seasonal returns look like from May to Sept for Global index, US sectors and industry, Cross asset and US equity factors (since 1994):
- Global index, HSCEI best +2.8% 54% hit (negative May June very positive July, very negative Aug and mild negative Sept), SPX +2.8% 65% hit (positive May, negative June, mild positive July Flat Aug and mild positive Sept), worst Japan -2.9% 35% hit (negative July Aug and Sept, EEM -2.3% 46% hit (negative May Jun Aug and very positive Sept)
- US sectors, best Tech +7.7% 65% hit (very positive May July Sept negative for June), Healthcare +3.8% 65% hit (mildly positive every month, worst Discretionary -0.4% 46% hit (negative June Aug and Sept), Industrials +0.6% 65% hit (negative June Aug and very positive Sept)
- US Industry, best Tech hardware +5.8% 62% hit (very positive May July Aug, negative June), Semis +5.7% 54% hit (very positive May July & Aug, negative June), Healthcare equip +5.2% 69% hit (positive May to Aug, flat Sept), Software +5.1% 73% hit (very positive May June Aug, flat July Sept), Pharma biotech +4.6% 58% hit (very positive July and Sept, flat rest of the month), Worst Autos -8.2% 35% hit (negative every month x July), Media -3.6% 35% hit (every month negative x July), Div Fins -0.1% 50% hit (negative June Aug, good July and Sep), Food Staples -0.1% 50% hit (negative June and Aug)
- Cross asset, best Crude +5.0% 62% hit (negative May, very positive June and Sept), Gold +2.8% 62% hit (negative May June July, good Aug and Sept), worst US yields (my note: meaning USTs HIGHER) -6.3% 42% hit (negative May July very much in Aug and Sept), Dollar -0.1% 42% hit (negative to flat in June July Aug and Sept
- US Factors, Price mo +1.1% 63% hit (very good May and July, negative Jun Aug and Sept, worst Beta -7.3% 42% hit (very bad May, negative June July, good Sept)
As McElligott adds, this “meh” seasonality also corresponds with this period where most of the “positive catalyst checklist” boxes made by clients in March/April in order to set scenarios to dip back-in from the long side have now largely been achieved. Of note, the ‘get constructive again’ starter kit established in March / early April is all green, so little upside left here:
- Massive monpol and fiscal pol response–CHECK
- flatten the curve in US cases–CHECK
- commencement of reopening on global and US state & local level–CHECK
- positive phase 1 Remdesivir data, or comments from REGN yesterday saying COVID19 antibody could be ready by Fall–CHECK
This has also affected the VIX:
What this meant then too and occurring simultaneously was a set of further positive inputs into the “vol normalization” process, following the various “short vol” stop-outs in late March—by late April we’d seen the return of Overwriters into “expensive” vols, while too we saw the resumption of an upwardly-sloping front-end of the VIX curve as an “all-clear” signal for the return of systematic “Short Vol” & VIX roll-down strategies
The drop in the VIX created mechanical covering of either legacy shorts (CTAs) or re-leveraging into longs from “vol control” / “tgt vol” space—and over the 1m stretch, and as we noted last week, we even got a day when the CTA signal had flipped back to “+100% Long,” which prompted Nomura to estimate ~$50B of CTA buying across US Eq futs on the month-long gradual / partial cover (from prior -100% position), while too our Vol Control model estimated ~ $15B bot over the past 2wks, as realized trailing vols reset gradually lower.
But now that these “positive catalysts” have largely been squeezed-out, the Nomura quant warns that “we are pivoting into said seasonality; an ugly forecast revision period for corp EPS; data continues to come-in even worse than expected as consumer psychology remains altered; the corporate cashflow disruption and imminent bankruptcy realities become front page daily news (particularly anticipating bloodshed in the energy space); and 2nd order white collar layoffs in corporate America all contribute to another sentiment swoon”
And then there is the new unknown element which is the China-US COVID / Trade War “hot potato,” where many see this rhetoric risk again growing over the Summer election cycle—and could really magnify the risks ahead of the U.S. Election, as Republican Govs look to reopen some states, while Democratic states stay slow on reopening and wait to see if another COVID wave 2.0 kicks-off…which could be seized into the election and act as a back-breaker for Republicans into Nov—either way, we have seen nothing but FXI / EEM vol buyers, with FXI Put Skew 98th %ile
- Note today the South China Morning Post article “Coronavirus: China could cut US debt holdings in response to White House Covid-19 compensation threats”
- Also with regards to China and their own COVID-19 recovery, here is Nomura’s China economist Ting Lu who states that the Golden Week data points to a weak Chinese economic recovery:
- “Tourism and other activity data from the past Labour Day Golden Week (1-5 May) suggest that China’s economy is gradually returning to normal, but the pace of the recovery is quite slow, as the Chinese government is still maintaining some social distancing measures, consumer confidence is clouded by elevated uncertainty, and plummeting exports dent household income and slash millions of jobs. Online sales were impressive during the holiday, though at the cost of the bulk of offline services and shopping mall visits. We maintain our -0.5% y-o-y forecast for real GDP growth in Q2 and believe markets might need to lower their expectations for Q2 growth.”
This, as McElligott conlcudes, is also why it seems that “the obvious trade the market is putting-on again so far in May and ahead of the Summer is a resumption of the “Everything Duration” dynamic within Equities—long Bond Proxies (Sec Growth and Def / Min Vol) vs back again short Cyclicals / Value / High Beta as a preferred hiding-spot / comfort-blanket—as such, I’d likely prefer to express this “Momentum” view than an outright “bearish Equities” one”
This “downbeat Summer” trade would then look like a move BACK TO THE FUTURE of the “everything duration” safe-place trade, which should mean that “Momentum Long” of Secular Growers and “Cash / Assets” factor (stuff that can grow profits and earnings without a hot cycle) and Bond Proxies / Min Vol / Defensives likely continue to outperf “Momentum Shorts” being Cyclicals/ Value factor (EBITDA / EV) / Size / High Beta
This reversal in sentiment is also why “1Y Price Momentum” is again exploding higher in May, +8.4% in just 3 sessions…
… as Secular Growth and segments of Quality rally, while Value / Beta / Vol / Default Risk / Commods -factors gets hammered.