By Charlie McElligott, head of cross-asset strategy at Nomura
Momentum Parties While Softer US Dollar, PBOC Actions Boost Risk-Assets
Global risk-sentiment in one asset: Offshore Yuan sees a powerful reversal STRONGER again overnight and is back through the “centrifugal pull” of 6.85, to 6.827 all the way from ~6.90 earlier (!)
And this is why, just out now: *PBOC SAID TO PLAN RESUMING COUNTER-CYCLICAL FACTOR IN YUAN FIX, which will likely contribute bias towards a STRONGER Yuan fixing vs Dollar
Along with a broadly weaker USD (G10 and EM), this is risk-asset stabilizing, with the “virtuous cycle” back in-play: firmer Commodities / higher “Inflation Expectations” (5Y Breakevens back above 1.985) and stronger Emerging Markets see better global Equities / higher UST Yields overnight
Macro-wise, the key STRUCTURAL “go forward” themes for risk-assets come down to aforementioned
- “USD Direction” (near-term) and
- U.S. Yield Curve “shape” (medium-term), as any “steepening” will likely be signaling that the market is “sniffing-out a slowdown” from “Peak Cycle,” and beginning to REMOVE rate hike projections from the front-end—this is why we’ve pushed the 1y and 2y expiration curve-caps as broad risk hedges
To this latter-point, I remain fixated on the inversion of EDZ9-Z0 spread, as well as the recent precipitous decline in March ’19 hike probabilities—going from 63.5% to now “just” 45% in less than a month
Tactically however, I remain focused on the U.S. Equities-centric theme of “the great performance puke of 2018,” as it will then act as a critical input / catalyst for “the next move” post-Labor Day.
I expect September to be “grabby” within U.S. Equities (particularly “Momentum” factor) on account of said “performance-anxiety” as funds are being “left behind” and thus, forced back into the market.
Anecdotally I’m being told of funds already taking-up “nets” and “chasing” already on account of this “FOMO,” following this enormous underperformance period of past months (and yes, I am aware that many view this as a “contrarian / bearish” indicator!)
This “performance puke” (since mid-May for some) was best-exemplified by the incredible drawdown in “1Y Momentum” factor, -8.8% from start June 5th to July 5th alone; this played-out in “acute reversals” in key status-quo themes: ‘Cyc / Def-,’ ‘Growth / Momentum vs Value / Quality-,’ ‘Small / Large-‘ all experienced powerful rebalances / rotations at times.
The issue has really been about the destruction of “short books” initially (many “High Short Interest” proxies +7% to 9% QTD), which then contributed to sloppy trades in “crowded longs” like Media, China Internet, Casinos, Video Games, all seeing sloppy EPS-related selloffs.
To be fair, some “Growth”–tilted investors have enjoyed a renaissance over the past few sessions; however, broad “consensual longs” continue to struggle against underperformance across various “Crowded Short” proxies.
My call to get long U.S. Equities “1Y Momentum” into September is going bonkers in the best of fashions—the Nomura Momentum Factor is now +3.1% in two sessions since walking-through my rationale on the call, as funds “leg into” the tactical trade—in these two sessions, both legs are working—“Mo Longs” are +1.8% (Tech / Cons Disc / Biotech reasserting themselves) while “Mo Shorts” are -1.3% (Industrials, Financials, broad “Defensives” again struggling).
With U.S. Equities “Momentum” now +6.9% MTD and +3.1% the past two sessions alone, I am already nearing initial profit-taking levels; however I do expect more strength again today with the positive “risk” backdrop and weaker USD setting-up for more of the same.
Finally to reiterate, I DO then believe that following this Equities “burst” into Sep that we will then see reinvigorated Oct cross-asset volatility.
- The macro-catalyst being the “QT escalation” theme I’ve been speaking-to leading to potential “interest rate volatility / tantrums”
- I too expect high-potential for “position asymmetry” to “tip-over,” as both systematic- and fundamental- investors accumulate leverage and large position size via lower realized volatility into the “risk rally”
Reminder—the QI long-term macro factor sensitivity model for SPX is showing three signs that U.S. Equities are becoming concerned about excessive Fed tightening, in-line with my “QE to QT” thesis:
- Long-term SPX model sensitivity to “Inflation Expectations” has now turned ‘negative’
- Long-term SPX model sensitivity to “US Real Rates” has now turned ‘negative’
- The formerly “positive sensitivity” of SPX to DXY too has ‘rolled-over’
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