After ramping for days despite all the 'bad' news from US macro data, today's 'good' news from the BLS (with payrolls printing better than expected) has prompted a deeper sell-off in stocks…
It appears that the Fed Hawks have regained the narrative this week, and rightfully so. As Nomura's Charlie McElligott the Bostic “September Pause” meme last week was a “low Delta” fiction which required multiple Fed-speakers (and Bostic later himself) to forcibly “clean-up” as it created a counter-productive impulse “easing” of financial conditions.
Mester and Brainard stepped-in to get “truthy” on Inflation priorities again, we have seen Dec Fed Funds accordingly pick-up ~16bps of implied “hiking” and take us back near 197bps of hikes by year-end (market envisioning a “50bps Jun / 50bps Jul / 50bps Sep / 25bps Nov / 25bps Dec” –type cadence for now).
This hawkish 'control' shift has moved us back into opposite-mode where good news is bad news (for stocks) and bad news is good news (for stocks).
And so, looking at the stock market in particular, McElligott writes that the trillion-dollar question is this:
Was the violent rally in “trash” / shorts / YTD losers that went bonkers yday – against YTD “winners” then turning underperformers – a sign of a simple further “de-grossing” from clients covering shorts and selling longs from the YTD thematic trade?
Or conversely, was this enormous explosion in “high multiple” speculative stuff a more constructive development with investors beginning to re-deploy, and an evolution towards a “tradeable bottom?”
On the latter point, the Nomura strategist points out that the thought-being that often-times coming off a market top, investor rotation into “safety” of Defensive, Low Risk, Quality, Dividends and Size (and also CLEARLY in the case of this particular cycle, thematically into “Cheap” Value with Inflation- / Interest Rate- sensitivity), while absolutely puking and purging out of former longs in “Expensive” highly speculative / high multiple / low profitability cash-burning Stocks i.e. Leverage-, Short Interest- and HF Crowding- factors—which has of course been the case QTD / YTD in US Equities factor & risk-premia space:
But then in May, you had the “everything sell-off” into lows, where both sides of the aforementioned sides – “trash” AND “quality” – were vomited.
And thereafter, during a stabilizing / “bottoming” process (hypothetically the past two weeks), you see funds begin to redeploy again into “cheap” stuff… which in this case, especially after the rally in “safety” / Quality which then got ironically “Expensive,” means that some investors are holding their noses and buying the junky “fallen angels”—which in this case means the Duration-proxy FAANG+ / Mega Cap Tech / Growth / Leverage / Low Profitability –universe
And that is EXACTLY what we experience yday and month-to-date – where, by definition, “1m Reversal Strategy” is the best performer, and broad factor performance has flipped on its head vs QTD / YTD leadership dynamics (Growth / Crowding / Leverage / Short Interest over Low Risk / Momentum / Cyclical Value / Quality / Size / Div / Defensive Value):
Additionally, it is worth-noting that some very significant “down days” are in the process of clearing from risk management near-dated 1m and 3m lookbacks, which actually could allow for more VaR / risk budget being deployed as well and further triangulate that the recent flows might actually be a “re-grossing”.
Finally, McElligott warns that next week’s Options flows are going to be a big deal to determine if this nascent “demand for Downside” / Puts continues and seemingly may-even accelerate ahead of the following hugely-important week of June 13th, which captures both FOMC and serial Op-Ex / VIXperation for real “fireworks” as potential inflection-point thereafter.
In fact, as SpotGamma highlights, this market still remains very well hedged by large, structural SPX put/VIX Call positions as shown below in their Delta Tilt chart.
We’ve suggested for several weeks now that traders were given the “green light” to sell short dated volatility. Whats interesting here is that while we do believe there is some of that short vol flow, its been more of a halt in put-buying (we covered this, and the related VVIX collapse here). This has been supportive of “risk on” behavior.
Traders only have one more week of before we hit the big VIX exp/FOMC/OPEX window, and the value of short dated volatility is shrinking.
This may mean that speculative “risk on” behavior is likely going to be stifled the closer we get to 6/13, particularly as the options-derived tailwind (gamma, vanna) is shifting to a gentle breeze.