RBC Market Commentary: "Under The Hood, It's Not Good"

With the "Trump reflation" rally fizzling, not helped by a Goldman note which forecast that no matter what Trump does, it will lead to a slowdown in the global economy, momentum chasers, pardon, traders are once again confused what to do next: if we are approaching an inflection point, and algos get cold feet about ramping upside stops, well, the downside beckons.

So, for some much needed perspective on what may happen, here is RBC's cross-asset wizard, Charlie McElligott explaining why "Under the Hood It's Not Good"

Spooz hovering near flat, while the long-end of USTs see a meaningful relief rally, boosted by Goldman’s “stagflation scenario” call (which outside the policy component is also receiving increased note from clients, in light of the US Dollar and RMB moves “deflation impulses”)...although now fading a bit again as meaningful IG issuance sees some rate lock sellers.  Outside of that though, I wanted to communicate on some performance observations.

As touched on this a.m. in “RBC Big Picture,” the single-name / sub-sector / sector level dispersion within both equities and credit universes has been gut-wrenching in the post-election period.  But also think about the past two week span: most funds went into a fierce de-risking mode (taking down gross, where others actually added to single-name shorts / took down nets) into the election event-risk, while since then, the market has found the point of max pain with a gap index jump higher, while under-the-hood, we’ve seen popular positioning and pairs-trade unwinds in almost every sector.  Just thematically, seeing more of this too: everything (for example) from biotech vs healthcare facilities, banks vs fintech, even Dow Industrials vs Nasdaq (outperf by 6.0% MTD already)…

There is clearly a ‘factor crowding’ issue at play here (as there was at start of year) — whether it’s ‘style’ (‘momentum’ and ‘anti-beta’ hammered while ‘value’ and ‘size’ scream higher) or previously mentioned ‘sector leans’ (everybody stuffed to gills on tech and discretionary, underweight financials and industrials) or ‘macro input’ (reflation / crude oil) — these market-neutral strategies are not supposed to see moves like this over multiple days (sorted by 5-day % return), let alone in a single day:

And thematically, on the 5-day % return view, we see ‘estimate momentum l/s, HF VIP l/s, growth l/s, price momentum l/s, mkt neutral earnings momentum, mkt neutral price momentum and mkt neutral anti-beta all taking it on the chin relative to SPX +3.8%.

With that, I’d be willing to bet that there are likely a number of “stop outs” occurring at market neutral and long-short shops. 

Let’s first look at a few performance spreads / ratios that are indicative of this wonkiness: 

SMALL CAP : LARGE CAP—

FINANCIALS : UTES RATIO—

TECH : BANK RATIO--

And it’s not just stocks of course where we saw mega-moves…

GOLD : COPPER RATIO—

DEVELOPED SOVEREIGN BOND INDEX SEES LARGEST 5-DAY DRAWDOWN IN HISTORY--Equivalent to the original “Taper Tantrum” sell-off in ’13.

LONG DURATION / DEFENSIVE EQUITIES--Frankly, by the looks of it, defensive stocks still have a ways to go lower as they play ‘catch-up’ to long-duration ETFs…skinny exits.  And I sit here twiddling my thumbs waiting for the first class-action lawsuit from retail against the “low vol” / “min vol” ETF products.

And one final thought that might be ‘at play’ here as well: tomorrow approximately marks the 45-day hedge fund redemption window into year-end—which to be fair is not how all funds operate (same require request a quarter ahead of time, so Sep for end of year redemption).  That said for this type, if funds haven’t been redeemed yet, they might still be in a position where they need to have cash on hand ‘in anticipation of redemption, meaning that some funds or strategies (relative value / stat arb / long-short / market-neutral) might be incapable of deploying into some of this spread blow-out, whereas under normal circumstances some would have potentially been there to help mitigate some of the bleeding.