It’s ugly out there.
While the headlines suggest things are dicey with all the major US equity indices in the red year-to-date, and in correction; under the surface things are going from worse to worserer…
and institutional pile-ons,
early Oct / Nov fund redemptions building into tax-loss selling into YE,
pension fund de-risking into a hiking-cycle (buying USTs / STRIPS vs selling Equities as they achieve funding ratios),
systematic trend funds again turning ‘short,’ very negative (~1st %ile) SPX index option greeks for both negative Delta- and Gamma-,
resumption of the buyback blackout window (already started for banks, transports and household goods),
slowing global growth…
…against shrinking G3 central bank balance sheets and net / net “tighter” financial conditions…
…and all into a Fed this week which due to enormous “dovish” expectations built-in has a risk of disappointing the markets with a more “hawkish” tone that has to remain somewhat “neutral” despite the “balance-of-risks” shifting to the downside.
That is Nomura cross asset strategy MD Charlie McElligott’s short, sweet, and entirely un-sanguine summary of all things going on that the mainstream is likely missing.
Global cross-asset markets look nearly identical to where they were 24 hrs ago– currently we see some modest mean-reversion of QTD price-action, likely on position flattening into the “real” final week of the year from a Fed event-risk- and liquidity- perspective: US Dollar again sharply lower (esp vs Euro strength, Gold strength and higher-beta EM firming), Global Equities very modestly higher and UST yield curve bull-steepening, partially fueled by more ugliness in Crude and Industrial Metals.
Yesterday within US Equities was very interesting because yes we saw “purge” (all S&P sectors lower by minimum 1% and led WEAKER by Defensives, perhaps tactical traders playing risk-off monetizing winners ahead of the Fed), with huge sell-program flows over the course of the US Equities afternoon session as per TICK INDEX flows > 1200 at a number of negative impulses.
But ahead of meetings today, let’s get right to it – why are we seeing such a profound “risk-off” move right now, one where the market reaction is so clearly outstripping the actual “slowing-growth” economic reaction (a 2019 story)? A few thoughts below…
EXPOSURE / LEVERAGE REDUCTION INTO THE NEW “HIGHER BASELINE VOL” WORLD AS WE HAVE TRANSITIONED “FROM QE TO QT”:
Without a doubt, one core theme I have continued messaging since February’s leveraged VIX ETN “vol event” was that the excesses of the QE era are being forcibly “shed” via both the unwind of leverage accumulation (ongoing VaR-down / gross-down / net-down of exposures as risk models simply do not allow for this much risk-budget in light of the realized volatility profile) and the slow-bleed of redemptions reversing-out of Equities funds—from retail- investors over the course of the year, with now too seeing institutional- investors piling-on
The greatest metric for the capture of the fund exposure gashing is not just Equities PB gross- & net- historically low %ile bands, but also the price-action of the “Beta” factor market-neutral strategy, which is now -19.1% QTD as long books (which were exceedingly “long market risk / high beta”) have been nuked-out, while at the same time, legacy shorts / underweights in “low vol” / “bond-proxies” (especially in light of the consensual nature of the “bearish rates” view) have exploded higher (“defensives” Utes, REITS, Staples and Healthcare are the S&P’s top four sectors QTD, and Healthcare and Utes are the S&P’s top two sectors and only sectors “up” YTD as well)—obviously the masses are not “set-up” for that market behavior
As such, we see the last week’s tectonic US Equities fund outflows: -$27.7bil (sub 1st %tile since 2000, 6th %tile as a % of AUM), with Institutional finally reducing in earnest -$11.9bil this week (however still +$76.3bil of buying for the year—so more potential supply to go) with Retail now really stepping it up -$15.5 bil this week (sub 1st %tile) and now 6m outflows hitting -$59bil (8th %tile) and over the year -$102.4bil…
…and this is coming with Nov and Dec as historically the 1st and 2nd best months for monthly US equities flows on avg since 2005 = Total puke, this is the “anti-seasonal” which nobody expected
US EQUITIES FUND FLOWS YTD:
Source: Nomura / EPFR
CFTC data confirmed this “institutional de-risking” across Asset Manager flows, with last Friday’s CFTC data showing showed an additional -$16.3B sold in US Equities futures last week (-$15.2B SPX, -$1.1B in Russell, and their aggregate ‘net long’ down to +$47.3B vs a long-term average of +$59.2B)
ASSET MANAGER SELLING OF US EQUITIES FUTURES LENGTH (SPX, RTY AND NDX) TURNS CAPITULATORY—2006 TO PRESENT:
And mind-you, this performance wobble came at the perfectly wrong-time for funds, where already fragile conditions due to “end-of-cycle” perception and a volatile geopolitical climate also occurred with the “tough part” of the calendar into significant fund redemption flows in Oct / Nov (ahead of the Q4 redemption request window in mid-Nov) and much larger “tax-loss selling” across the various fiscal year-ends of Oct / Nov / Dec…
Source: Nomura, CFTC
PENSION DE-RISKING OUT OF EQUITIES / INTO FIXED-INCOME:
To my point in Friday’s note, I received a little more historical ‘fleshing-out’ of my point on pension fund behavior into hiking cycles and this incentivizing de-risking flows (buy bonds, sell equities as funding ratios normalize towards targets) with this chart from my Fixed-Income Strategy colleague Sam Wen—which further corroborates my view:
And finally, McElligott warns, don’t sleep on yesterday’s TIC data, which showed that foreigners sold -$22B of US Equities in October, the sixth consecutive month of selling where official- and private- foreign investors sold a cumulative -$124B of stocks—a new (bad) record…
Weaponization of stocks as “trade war” fodder, anyone?!