Explaining The "General Violence Of The Market's Extreme Moves"

Earlier today we reported that based on various internal metrics, the market-neutral quant space is suffering one of the most violent deleveraging episodes since the infamous quant blow up in August 2007.

But what is really going on below the surface to force these dramatic moves which may not seem like much to the untrained eye, but to PMs managing 10x levered market neutral funds are earthshattering. For the answer we go to the head of US cash trading at RBC, Charlie McElligott, who has given the most succint explanation yet.

Big Picture: HF Positioning/13Fs/Macro Unwinds

  • Another macro trade reversal today, with stocks / crude / EM / HY sharply higher, against USTs / bunds / EDs / vol lower,  as we see a ‘risk-ON’ pivot from an under-positioned / over-cashed market.
  • Taking this a step further, ‘micro’ within stocks shows further market-neutral and long-short ‘lunging,’ which is of course predicating on extremely ill-timed / wrong-footed ‘grossing-up’ of short books, while net exposure was cut to multi-year lows (via selling longs).  All of this of course, into the teeth of a 100+ point face-ripper in Spooz.  

Currently today shows approx. 100 to 150bps of short book proxy outperformance vs index, and about 100 to 150bps of outperformance versus ‘favorite long’ proxies—almost a mirror-image of yesterday/ See the monitor:

As a matter of fact, MS PB data shows that Tuesday was the largest cover day since Oct 2014, driven by both fundamental accounts AND quants.  Which segues nicely into the next point

As highlighted last night in the special post-close version of “RBC Big Picture,” the extent of the recent equity market-neutral deleveraging (and concurrent pnl destruction) is on par with the US debt downgrade / Lehman / Bear trades.  Again a repeat from last night’s piece but this returns histogram captures it perfectly:

When you see multiple periods of -1% returns consecutively, against AUM leveraged at 10 to 14x’s, the sheer enormity of notional $$$’s plowing ‘into’ shorts on covers and ‘out of’ longs is insanely huge, and dwarfs other flows.  Thus, the general violence of these extreme moves—these market forces are not just huge, but due to the nature of many of the equity quant models being derived from the same ‘core’ theses, the amplification / ‘echo’ of these books sees inherent ‘crowding’ / ‘herding.’

13Fs: Q4 filings showing the extent of the hedge fund wide destruction.  Look at the positioning into start of ‘16, per the most heavily weighted Q4 sectors / allocations--Financials at 21.2%, Info Tech at 20.1%, Consumer Discretionary at 16.8% and Health Care at 13.2%:

Now, look at the S&P worst performing sectors YTD—Cons Disc, Info Tech, Health Care and Fins:

THE HUMANITY.  Obviously, this goes hand-in-hand with the points above on the extent of the performance-pain, dragging down all equities players.
Turning to another equities tailwind, how about the $22B of US IG issuance unleashed yesterday?!  For context, it was the second largest day off paper YTD.  This is most notable for the equities crowd not just because it shows money being ‘put to work,’ but becausethe majority of that debt was ear-marked for stock repurchases (AAPL, IBM).   GS data is showing us that YTD buyback announcements are off to their strongest start ever at $132B—last week alone saw 47 new BBs totaling $42B authorized. 
Piling-onto the squeeze-theme is the ‘turn’ in CTA / managed futures positioning: price momentum has shifted in SPX, crude and USTs / EDs, and need be monitored for further break-out.  This certainly would add considerable fuel to the equities melt-up, as remember, being ‘price insensitive’ goes both-ways…but can also add to performance-issues, with much of that stock short base still built via Energy, Industrials and Materials.  Ouch.
Also worth noting, Atlanta Fed Q1 GDP tracker today is at +2.7% (up from 0.7% in January).  This ‘growthier’ move could definitely catch those who have positioned for disinflation /deflation or the dreaded recession AWFULLY upside-down.