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Yield Spike Sparks “Calamity” In Quant Funds; Macro Managers Massacred By Market Meltup

Courtesy of ZeroHedge View original post here.

Billionaire fund manager Stan Druckenmiller admitted this morning he was "far too cautious" during the current market meltup, and as Nomura's Charlie McElligott notes, Druck is far from alone as Macro Hedge Funds got caught "flat-footed" by the "rip-show" in global equities.

As McElligott notes, the recovery in risk-sentiment into the global economic “reopening” has of course been breath-taking, as the U.S. May NFP posted a shocking +4.2 z-score upside surprise, while the U-Rate too was smashing +4.3 z-score positive surprise – with both triggering a wave of unwinds from the YTD legacy risk-off / FTQ trade.

And as the macro “recovery” narrative has shifted over the past few weeks, the Fed’s desired “reach for yield” behavior (to create “wealth affect” via financial asset inflation and stabilization of “financial conditions” which can create a virtuous economic feedback loop) has been achieved in earnest, with risk-free yields suffering under YCC / negative rate talk relative to spread-product and risk-assets, which are de facto “back-stopped” by outright Fed purchases in Credit and “The Put” to do more:

  • ICI data showed a rollicking -$43B outflow from taxable government bond funds for the week ending Jun 3

  • EPFR data from last Thu showed a 1 week -$26B outflow from US Money Mkt funds, just 7th %ile outcome since 2000—as the “grab” sees capitulation back into “risk”

However, despite the capitulative flows, the Nomura strategist warns that it is critical to note that in the long-end – and now more recently on Friday, the intermediate space – we have cheapened to enough of an extent where we are finally seeing both Foreign- and Domestic- “real money” step-in, especially as the yield pick-up for FX-hedged investors is at most attractive levels seen in years – potentially acting to counterbalance some of this systematic selling pressure – ALONG WITH a few “up days” followed by more “down days” in the CTA look-back / look-ahead model windows, which could see the position signal “chop”

But it's not just bond bulls and stock bears that have suffered a bloodbath. As McElligott points out, the bond selloff and bear-steepening in yields has created a "calamity" in US equity quant markets as factors exploded their old regimes.

Thank the heavens I closed the “Mo Long” tactical call after the last day of May as a winning trade…

…because since then, “1Y Price Momentum” factor is now -31.5% in only five sessions MTD (-10.5 sigma 5d aggregate move, rel 10Y lookback) – evidencing the colossal pain caused by the extreme (and forced) grossing-down of “shorts” in those most economically-sensitive “Value / High Beta / Small Cap” Cyclical spaces…

Source: Nomura-Instinet, Bloomberg

which ultimately has led to the tremendous underperformance MTD in the “crowded longs” like Secular Growth Tech (NDX “just” +2.6% MTD vs SPX +4.9% and RTY +9.0%)

Source: Nomura-Instinet, Bloomberg

And as “Growth” factor market-neutral succumbs to the “Value” rebalancing into this “suddenly less-bad” economic worldview (Growth Shorts are Value Longs—thus, dust / flames / lights-out), we see a years-worth of factor dynamics being wiped as well.

Source: Nomura-Instinet, Bloomberg

But, as Morgan Stanley's Mike Wilson warned so plainly"sharply rising yields could have knock-on implications for equity portfolios." After all, one just needs to recall the dramatic surge in September 2018 following Powell's hawkish comments, that sent stocks tumbling and 10Y yields surging.

So stock market bears are now banking on a yield back-up, but there is hope for rational investors who see the fundamentals lagging and understand this is nothing but a liquidity-driven over-reaction.

As McElligott notes, the importance of the June Serial / Quarterly expiration with its monster open interest meaning a likely impulse “unshackling” of current “Long $Gamma, cannot be over-estimated.

The massive June qtrly expiration tends to coincide with the buyback blackout – so we have tended to see markets rally going into the expiration – ESPECIALLY when “over-returning” going-in (as overwriters have ITM options they’re short which are in the money and need to be rolled-out, while the market is long a ton of gamma – all while Corporates are going into their pre-EPS blackouts and thus tend to ramp up their stock buybacks).

And it just so happens that the next week happens to post a very “risk-ON” seasonality to further feed the Cyclical / Value grab in Equities into the OpEx melt-up:

Source: Nomura

However these catalysts for a melt-up going into OpEx then reverse engines for approx. 1w to 2w coming-out, with ~42% of the Gamma rolling off and at the same time that the corp buyback blackout begins (led by….FINANCIALS who stop buying-back first, gulp).

Source: Nomura

So while there is disagreement over the nuances and fringes, one thing that many strategists agree on is that a continuation of the violent move higher in yields will result in anything from a sharp market correction to another violent crash a la q4 2018… and June's op-ex may be the most immediate catalyst.

As McElligott concludes ominously, just as the market begins to get “very long,” with the %Delta %ile approach +90th “extremes”… with a likely MONSTROUS “gamma run-off” to come

…caveat emptor.


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