As Market Plunges, Bob Janjuah Opines: "Tactical Short Risk Time"

Tyler Durden's picture

Dow Jones down 250, and a new bearish letter from Bob Janjuah? Lucky coincidence? Or conspiracy? You decide. From Bob: "How to play it? The SPX is the obvious pure risk short because of how rich it is against other equity markets. Outright is fine, ao are options. Take a look at January 1350 puts for example currently trading at 20. If doing outright we would recommend a stop just above the recent highs at 1475. We also like the USD and Treasuries because the market has seen time and time again US problems do not lead to selling of (safe) US assets and it can and we think will be the same again."

Full Nomura note

Tactical Short Risk time

  • After a decent run markets have priced in a lot of good news and vol pricing suggests they are not paying sufficient attention to upcoming event risk.
  • Key near-term risks are political; the US election, the fiscal cliff debate that follows it and the long-term outlook for US monetary policy that is dependent on the result. There is also the Spanish regional election.
  • We see evidence that the market is positioned long of risk.
  • The earnings season thus far has not been good and economic data in the US and Europe are, at best, mixed, relative to expectations of a Q4 rebound that we believe may be disappointed.
  • The trades we like for a tactical play now are selling SPX (outright or via options), buying the USD (except against the JPY), buying US rates – 5yr outright or 10yr against swaps, and for those in the metals space we would look at buying gold at these kind of levels.
  • As always all views mentioned are solely the Macro Strategy team’s and not Nomura’s house view unless explicitly stated otherwise.

We shifted to a structurally neutral bias one month ago and since then we have watched the SPX rally to 1470 and back down to the 1420s twice. After that range-trading we expect that a break lower can now be seen with a reasonable near-term target around 1300.

While all upcoming risks as mentioned above are very much in the "known unknowns? category, it is still a reasonable call as a strategist to say whether they have been sufficiently priced or not. We think not.

Why? Because the SPX remains in its recent range (or just breaking out of it as we write) VIX and other volatility measures have remained very low and CFTC data show S&P net longs at their highest relative level since June 2009.

Why is the market behaving like this? We wonder if investors have looked at the relative returns this year (i.e. the degree to which risk has outperformed risk-free) and decided that because of this they need to take some "risk? on risk, which would explain why the positioning metric mentioned above has gone to this 3yr+ net long from a net short as little as five weeks ago.

We also think that a lot of complacency has crept in around Europe (OMT seen solving a lot more than we can see it does), and around a Q4 rebound which has been supported by better Chinese data, but not as yet so convincingly by Western data.

How to play it? The SPX is the obvious pure risk short because of how rich it is against other equity markets. Outright is fine, so are options. Take a look at January 1350 puts for example currently trading at 20. If doing outright we would recommend a stop just above the recent highs at 1475. We also like the USD and Treasuries because the market has seen time and time again US problems do not lead to selling of (safe) US assets and it can and we think will be the same again.

The USD looks cheap on a DXY basis, and that is probably the best trade to position for rather than trying to pick any one to pair it against, though if you put us on the spot our favourite to sell against it would be GBP and our least favourite JPY (for obvious reasons). On cable, we note that 3m vol is pressing close to the multi-year lows from 2007, so again options look a great way of positioning this.

Treasuries have had a tough time recently and have pushed back up to some attractive levels. If there is a true fiscal cliff scenario then we think Treasuries will rally even without the almost inevitable buying of them by the Fed (i.e. almost inevitable under that scenario). We believe that 5yr Treasuries can easily reverse the recent 15bp cheapening, but our preferred trade is buying 10yr against swaps from 5bp last looking for a move up to 20bp, as the perceived outlook for financial deteriorates.

Lastly, gold has fallen ~$100 recently and if you wish to position for a rise in global uncertainty and some additional Fed action being priced in then we think these look like attractive entry levels.

Which trades for a portfolio? We choose the outright short SPX and 10yr US swap spreads – we only want two trades as we want to be tactical here and while we think options offer good value across asset classes, the clarity of the view inherent in outright positions leads us to go for those in the portfolio, but we most certainly would not put you off options trades to express these views at all.

Good luck, this year's trades and the two new ones below.