Yesterday was one for the record books: as a result of the unleashed value-able animal spirits following the furious if brief euphoria that Pfizer has somehow cured covid (it hasn't), the "Insane, Tectonic" rotation from momentum stocks to value names left most quants dazed and confused, with the market-neutral momentum strategy suffering its biggest drop on record.
Nomura's Charlie McElligott provides another way of contextualizing yesterday's rout, writing that Monday was the largest one-day Momentum factor crash in the history of our data, -24.5% on the session (i.e., 0.0%ile) "as “Mo Longs” were destroyed, with many “Growth” factors experiencing ~ -7 to -15 standard deviation moves, while “Mo Shorts” exploded higher causing pain, with “Value” factors experiencing +8 to +12 SD moves."
And speaking of multiple sigma moves, if one does a 10+ year lookback (going back to Jan 2010) on 1-day "Momentum" return, Charlies points out that yesterday was the "worst drawdown ever", and a record 15 standard deviation event over that same 10Y period.
So with this historic flush now in the history books, is it once again safe to buy the tip in momentum/FAAMGs/tech?
According to McElliggott, the answer is a resounding no, as "momentum" shocks rarely happen in isolation, especially in the case of a market which is attempting to anticipate “regime change” by pulling-forward future growth- and inflation- expectations (in this case, he is referring to Vaccine trial efficacy and the potential it could hasten the reopening/ renormalization of the US economy).
Conveniently, one can backtest market returns after massive momentum crashes, and that's just what the Nomura quant has done, looking at forward returns after "Mo Crashes" (he had to widen the band out from “worst ever” to 0.2%ile prior drawdowns, which included Aug 2020, April 2020, March 2016, Oct 2015, March 09, Nov 08 and Jan 01), and the takeaways were:
- 1) Momentum factor continues to struggle weaker in the near-term and then again long-term, -2.8% median return out 2m before stabilizing out 6m at med return +2.2%, then a full regime change out 12m, with median return for the factor -14.9%;
- 2) Mo Longs "chop" out and are relatively lackluster out 3m;
- 3) Most importantly from the “Value” side of this equation, “Mo Shorts” chop to marginally higher next 3m, before later exploding higher (more “regime change”) in 6m +16.5% med return, and out 12m at +22.7%, higher at a remarkable 83% hit rate
Looking at today's action, one can certainly see a continuation of this furious unwind, with yet another "whopper" of Russell over Nasdaq outperformance, and a sustained follow-through of the "Value over Growth" impulse on the “renormalization” pull-forward, so as Charlie predicts, "more "Momentum" beat-down in the cards ahead."
Backtesting aside, Nomura next uses the Quant Insight tool’s valuation model to get a current snapshot sense of richness/cheapness of various ETF ratio expressions of “cyclical value”/“economically-sensitives” versus the current macro regime. The results are below:
Finally, a quick look at market technicals reveals that systematic positioning and the Treasury futures selling/deleveraging we saw in the CTA Trend model yesterday, when an estimate ~$22B in TY was sold as CTAs delevered to +22% Long from prior +60% Long, what Charlie says is important now is that his model continues to load the 12-month window at 61.2% weighting—which is important for the overall model signal in TY remaining “long,” because all other signal tenors are now “short” (2w, 1m, 3m and 6m all “short” and thus the systematic “sell” flow). This means that because of current loading splits, we are "far away from further deleveraging levels because the 12m model remains so deeply “in trend”—with the nearest trigger-point actually being a “buy” up at 138.5 for today on what would require a substantial, but not impossible, rally."
In short, CTAs are unlikely to pressure continued aggressive TY sales in the coming days even if the 10Y jumps above 1.00%
To this point, McElligott quotes the bank's Rates desk strategist Darren Shames, who said that during the continued move cheaper on heavy volumes overnight (at 2x’s recent overnight average) they began to see the emergence of foreign buyers targeting the much-discussed 90-.95 area in 10s, with the desk also noting attractive entry point in 5s as the potential best-play from the long-side if the current stabilization gains steam.
One final question: with the Momentum trade dead for the next 2-3 months, is there anything that could "kibosh" this positive economic impulse pull forward Value factor renaissance from here?
Well, according to the Nomura strategist, outside of the COVID trajectory and seeing states re-restrict activity/close schools slowing data again in the absence of a deployed vaccine being able to change daily behaviors of people and their economic activities, the Fed will play a major role here on the macro rates side. As such, and as we said yesterday, if the bond puke get sloppier from here, we already know that the Fed plans to extend the duration /WAM of the portfolio or size of the overall QE purchases, or otherwise engage in Yield Curve Control...
Does the Fed hint at YCC next to avoid a disorderly move in yields— zerohedge (@zerohedge) November 10, 2020
... because they cannot allow tighter financial conditions risk the extremely fragile economic recovery… and if that leads to a big bull-flattening in UST curves, "it would be a strong headwind for sustained outperformance of “Value” factor", according to Nomura.