Two months ago, to the chagrin of a generation of traders, Morgan Stanley made a dismal observation: Price action in 2018 has shown that ‘buy the dip’ is on its way out. To wit, buying the S&P 500 after a down week was a profitable strategy from 2005 through 2017, and buying these dips fueled most of the post-crisis S&P 500 gains (relative to buying after the market rallied). But in 2018 ‘buying the dip’ has been a negative return strategy for the first time in 13 years. In other words, “buying the fucking dip” is no longer the winning strategy it had been for years (even if buying the most shorted hedge fund names still is a stable generator of alpha).
However, a more concerning observation is that while BTFD may no longer work, it has been replaced with an even more troubling trend for market bulls: Selling The Fucking Rip, or as it is also known, STFR.
This selling of rallies has been especially obvious for the past two weeks as traders have observed ongoing intra- US session asset-allocation trades out of the S&P and into TY, with simultaneous volume spikes / blocks trading in ESH9 (selling) and THY9 (buying) at a number of points throughout the day, but usually after the European close, and toward the end of the trading day.
“SELL THE RIPS” IN SPOOZ BECOMING THE NORM
So what is behind this pernicious, for bulls if quite welcome for bears, pattern?
Here, Nomura’s Charlie McElligott has some thoughts and in his morning note reminds clients that he had previously highlighted a similar potential observation YTD between the inverse relationship of UST stripping activity (buying US fixed-income) and the SMART index (end of day US Equities flows being sold)—which indicates a similar trend with pension fund de-risking throughout 2018, as their funding ratios sit at post GFC highs.
In other words, one possible culprit is pension funds who have decided that the market may have peaked, and are taking advantage of the recent selldown in fixed income, to reallocate back from stocks and into bonds, locking in less risky funding ratios.
And, as McElligott concludes, this equities de-risking/outflow corroborates what we touched upon this morning, namely this week’s EPFR fund flows data which showed an astounding -$27.7B outflow for US Equities (Institutional, Retail, Active and Passive combined), the second worst weekly redemption of the past 1Y period.
Meanwhile, the equity weakness is being coupled with surprising strong bid for US Treasuries, further confirmation of an intraday Pension reallocation trade.
According to McElligott, the price-action in the long-end of late indicates “that we potentially are seeing “real money” players back involved for the first-time in awhile, “toe-dipping” again in adding / receiving as the global slowdown story picks-up steam amidst growing 2019 / 2020 recession belief”, a hypothesis which is further validated by the sharp rebound in direct bidders in recent auctions and especially yesterday’s 30Y which we have documented extensively, as the “buyers-strike” in long duration auctions seems to have ended.
This Treasury bid could include large overseas pensions (which are less sensitive to hedge costs than say Lifers), Risk-Parity (as previously-stated, our QIS RP model estimated the risk-parity universe as a large buyer of both USTs and JGBs over the past month and a half) and potentially, resumption of long-end buying from “official” overseas sources as well (with market speculation that there could be an implicit agreement / gesture coming out of the G20 trade truce arrangement), McElligott notes.
One tangent to note: the bid has been more evident in futures and derivatives (as they are “off-balance sheet” expressions into a liquidity constrained YE reality), which is reflected in the fresh record dealer holdings of USTs and which the Nomura strategist notes has made made futures super rich to cash, creating arb opportunities in the cash/futures basis as the calendar is about to flip.
Finally, as to who or what is the real reason behind these inexplicable bouts of “selling the rip”, whoever it is, the biggest threat to the market is that once the pattern manifests itself enough times it becomes a self-fulfilling prophecy at which point it’s not a question of who started it – as everyone will be doing it – but rather at what point does the Fed step in to stop it.