Just as we warned about, Friday's option expiration - one of the largest for single stock options ever - sparked yesterday's "gamma unclench" in markets.
While the moves at the index-level were ho-hum (SPX -0.3%, Russell -0.4%, Nasdaq -1.2%), the intraday reversal and "free to move about the cabin"-level was significant: SPX was -1.3% from hi to lo; RTY -1.6% hi to lo; NDX -2.3% hi to lo and closing at worst levels.
In this case, Nomura's Charlie McElligott notes that the macro catalyst which “unleashed” the Op-Ex kraken (the market’s ability to move via the sharp drop-off in Dealer Gamma hedging barriers) was the renomination of Jerome Powell for his second term as head of the Federal Reserve, as Inflation Breakevens collapsed and Real Yields exploded higher (pulling forward “tighter financial conditions”), because the market was “green-lighted” to further price 1) faster taper in order to 2) pull-ahead more Fed rate hikes, with Jun ’22 now priced for “lift-off”.
Further, when adding-in two grim UST auctions in 2Y and 5Y (Darren Shames notes we’ve now had SEVEN consecutive “tails” in a row, “ooof”), the front-end and the belly were absolutely rekt (EDU3 Sep23 ED$ -14.5, a -3.5 z-score 1 day move). And downside buying has again resumed overnight in UST options, with TY week3 128.5 / 127.5 Put Spread bot 12,5k x’s…and FVF2 119.75 Put bot 10k x’s.
However, the Nomura MD points out that the true movement wasn’t on the Equities index level of course, but instead, on the risk-prem level, where “expensive / high-multiple / low-profit” secular Growth - which is a leveraged “duration” asset - were absolutely nuked-out...
...while “cheap” cyclical Value - which is effectively a “bearish fixed-income” expression - ripped higher, as the Rates market reset to this “green-lighted” hawkish footing and allowing “late cycle” dynamics to accelerate internally / thematically (sectors like Energy, Fins, Materials outperf Growth Tech / Cons Disc in “late cycle”)
As McElligott pointed out so eloquently: it was the “under the surface” stuff that got deliciously-weird.
The massive dispersion of performance behavior due to Duration / Rates-sensitivity names which somewhat masked the actual bloodshed on the risk-prem factor / thematic level, as there was single-name PAIN for managers who’ve been hiding in the “bond proxy” hyper-growth / no-profit stuff, and kicked-off a powerful unwind over the course of the day and again reaccelerating into the close:
Nomura Cyclical Value Factor +3.2% (+2.1 z-score), with (“cheap”) Cyclical Value Longs +1.3% while Cyclical Value Shorts (i.e. “expensive Growth”) were -1.8%
Mega Cap Tech vs. Unprofitable Tech +4.2% (and now +11.7% in 2d) as funds run to the safety of “The Generals”
Nomura Hedge Fund Crowding Factor -1.5% (-2.1 z-score), with HF Most Crowded -1.8% while HF Least Crowded was +0.4%
Wolfe US SHIELD Long / Short Strategy -0.7% (a stunning -3.5 z-score 1d move)
Wolfe Recent IPOs Basket -3.7%
R&D / Sales Factor -3.6%
ARKK (ARK Innovation ETF) -4.2%
Secular (Expensive) Tech / Cyclical Tech -4.9%
High Multiple Tech Longs –6.4%
Additionally, the Nomura strategist highlights the fact that the purported “ARKK Doomsday Machine” trade lives to fight another day…and it’s been one hell of a grim month inside the ETF itself—look at the November-to-date returns in the underlying ARKK components, as they are riding the struggle-bus: 40 of 44 names held are down, 25 of those are down > that -10% MTD and 9 are down > 20% MTD...
Finally, McElligott notes that this week's price-action (and frankly, all of the month-to-date as well) echoes what I have previously shown with our “Nomura Economic Quadrant” work and the recent transition from “Expansion” into “Slowdown” phase - which is a selloff in “Growth” and “HF Crowding”…versus an outperformance in “Cyclical Value” and “1m Reversal” in the medium term:
So, what does all this mean for stocks from here?
McElligott has run the numbers for SPX forward returns for the “HF Crowded Longs U/P SPX -4.0% on 1w horizon” event that has occurred this week - they are not pretty:
There are only 4 prior triggers in the sample, but again, the point is that this recent “crowding underperformance” dynamic is an outlier, and has coincided with extremely “binary” price-action on the SPX forward median return level:
2 scenarios (3/5/2020 and 10/2/2008) see SPX go WAY down in the medium-term (it’s simply very difficult to ever get a test to show “negative SPX” returns of this magnitude, so this is pretty wild), before stabilizing and rallying HUGE thereafter…
while the other 2 (9/29/2015 and 8/8/2011) evidence a grind higher out a few months, before really running powerfully higher out 6m / 12m.
SPX index MEDIAN RETURNS for this 0.6%ile trigger of “Crowded HF Longs u/p SPX -4.0% on 1w returns” test: 1d: +0.3% 50% hit; 1w: -6.4% 50% hit; 2w: -7.3% 50% hit; 1m: -3.0% 50% hit; 2m: -0.5% 50% hit; 3m: +6.6% 75% hit; 6m: +13.9% 75% hit; 12m: +20.2% 75% hit.
So while the low sample size (for a reason - because this outcome is truly extreme) really signals that this is bifurcated, a potential “fork in the road" as the S&P struggles locally out the next 2w / 1m…before rallying out 3m, then going sharply higher out 6m / 12m.
For now, today is playing out along those lines with the gamma unclenching allowing stocks to fade fast, exactly like yesterday.