Back on November 9, after 10Y yields had shot up by 20bps in one week and in response to Marko Kolanovic's latest thesis that bond yields would continue rising, and could jump as much as another 150bps before the spike in rates fizzled, we said that we disagree and countered that CTAs - which we pointed out were the biggest drivers for the sharp selloff in rates - had largely liquidated their legacy long positions...
... and as a result we said that the selling in Treasurys is over, and that the "great rotation" out of value and into momentum, a simple pair trade proxy for 10Y yields, was about to reverse.
A little over a week later, we were right on both counts, with 10Y yields sliding almost 20bps from Nov 9, while momentum has outperformed value every single day in the past week.
More importantly, our assessment on the relative CTA positioning was spot on, and as Nomura's Charlie McElligott writes today, Systematic CTA investors have stormed back into duration and, "which in-turn sees the aggregate CTA signal in TY and ED now back to "+100% Long" (and for that matter, across all our G10 Bonds and Rates positions in the model)."
That said, without further "risk off" headlines, the Nomura quant believes it is now likely that we’re back in a range-bound spot for USTs now, because after puking their positions two weeks ago, Systematic CTAs are once again fully long and have no incremental buying left to do.
Yet while CTAs are once again loading up on bonds, and steamrolling all those who listened to JPM's latest "once in a decade" trade reco to buy value and sell momentum, stocks have also been surging, with Nomura alleging that the ongoing risk-rally is a mix of
- Historically strong seasonality in the S&P (the previously noted surge in stock buybacks post EPS and performance-chasing “FOMO grab” into YE)
- Clients rolling-out upside
- Overwriters covering short strikes as part of an overall impulse “higher”
As McElligott further notes, the market now has the largest SPX/SPY consolidated options Gamma strike now "up" at 3150 ($9.6B), with spot “pinned” between there and the 3100 strike ($8.7B), assisted with further stickiness “inline” at 3125 ($5.7B) and 3130 ($5.3B), which provides a springboard for the S&P on every drop below 3,100. Meanwhile, dealer delta remains "insanely long" at $503B, or roughly the 99th %ile since 2013.
Besides the traditional gamma excuse to push up stocks, Nomura points out several additional positional and flow dynamics which are boosting US Equities:
1. The massive notional of the Leveraged Fund “Net Short” in SPX futures (-$44B, just 4th %ile since 2006) is being squeezed by the relentless Asset Manager buying (purchases of $9.1B more last week, makes $142B Net Long in SPX futures—99th percentile since 2006).
2. The "incredibly low" Hedge Fund L/S exposure to the markets, i.e., "Beta to SPX" (still mediocre “Nets” relative to the scale of the rally PLUS this “short” in Futs as all hedges drag), which is now matched at the lowest percentlile on record since 2003 and likely abetting “grabby” behavior.
VIX ETNs began reducing their 99th %ile “Net Long” Vega position last week, decreasing by $6.7mm—as a second-order "bid" to stocks. We are also again seeing the multi-day impact of the VIX ETN "futures roll" into settlement tomorrow, which would mark the 8th month in a row where VIX has hit local lows either the day into or the day of expiry as the ETNs sell UX1 to buy UX2—punishing front VIX future in the process as another “Equities slingshot” boost.
So while the various technical factors for a continued levitation are all there, which explains why the S&P has had just 2 down days in November (at least until today), what about another topic near and dear to Wall Street's heart - the violent moves in select factors?
Here, as Nomura's other quant, Masanari Takada writes, what had been a nearly consistently unfolding factor reversal in DM equities is also winding down in parallel with the end of selling in Treasuries. Factors that correlate positively with stock market sentiment, such as the performance of cyclicals over defensives and the reversal factor, have seen markedly improved performance recently (as measured by their 3-month Sharpe ratios). Going the other way, low-vol, quality, and other such factors that correlate negatively with sentiment are performing much more poorly now. The contrast here is stark, and moreover, performance in percentile terms for a five-year window is at 85% for the cyclical-defensive factor (on the one hand) and at just 18% for low-vol and 8% for momentum (on the other).
Said otherwise, the spontaneous and swift reversal in equity factors may be poised to wind down and proceed more slowly. However, it is worth noting that the factor reversal may be forced back into higher gear if the bullish narrative stages a comeback, as present factor movements are closely linked to what happens with sentiment... and especially with the 10Y yield. In that event, however, buying of the cyclical-defensive factor and selling of the low-vol factor could quickly start to look overheated, making it look unlikely that the performance would be sustainable from a risk-reward standpoint
Finally, taking a step back, and looking at CTAs, this time in the broader S&P, Nomura notes that in May, August, and October of this year, CTAs' net long position in equity futures has topped out and collapsed after reaching something like the current level. This, to Takada, has been an indication that CTAs' net buying on each occasion this year "has been something like an opening gambit carried out as a means of feeling out the market."
If the market were to see a boost from fundamentals, or if other investors were to start piling into the market out of a fear of missing out, then we would expect CTAs to proceed to making a genuine long play on equity futures.
As such, anyone seeking to find how much further CTAs might go with their trend-chasing buying of equities and selling of bonds should do well to keep a wary eye on the direction of stock market sentiment, which has clearly stopped improving for now.