Nomura Warns, Yesterday's "Brutal Factor Unwind" Is Becoming More "Systemic"

Yesterday's bloodbath in markets - after such exuberance on Monday - is set to continue if historical precedents are anything to go by. Nomura's cross-asset-strategy chief Charlie McElligott notes that yesterday’s equities pain via a brutal factor-unwind resembles one of the most violent performance drawdowns in recent history - that of Jan / Feb 2016 - and seemingly "idiosyncratic risk" is now turning more "systemic" in crowded Tech "data" plays as "death-by-paper-cut" now becoming a longer-term regulatory overhang of their core "data commodity."

Worrying words indeed. McElligott first breaks down just what happened yesterday - and where the real "cataclysmic" pain was felt - before moving on to 'what happens next'?


  • The -4.1 z-score move in “Cash / Assets” factor - the best performing factor strategy of the past 2 years - speaks to likely forced capitulation / book blowouts, similar to what we experienced back in Feb 2016 as “equities market-neutral” performance was crushed in a violently-short period of time

  • “Cash / Assets” is important because it is a pure proxy of the “Growth over Value” theme which has been the dominant reality of the post-GFC period and has accelerated in the past two years to look a lot like “Momentum” factor

  • The analogs of similarly extreme prior drawdowns in “Cash / Assets” (again effectively a “Growth over Value” AND expression in its current-form) give us both “good” and “bad” forward-looking news

    • The “good” - said prior “extreme drawdowns” with this particular “Growth over Value” proxy ( “Cash / Assets” factor) have seen mean-reversion HIGHER at the SPX level on average from a 1w to 3m basis

    • The “bad” - “Cash / Assets” factor typically continues to underperform primarily due to the outperformance of the “short” leg from here (“defensives”)

  • This then is an equities performance risk because “Cash / Assets” is effectively “Momentum” long-short and thus, mirrors general Equities Hedge Fund Long-Short positioning

  • Further squeeze in the “short leg” of “Cash Assets” too squeezes the “short leg” of “Momentum” via the broad equities fund underweight / short in the “duration-sensitives” like REITs and Utilities

  • This in turn only puts MORE pressure on the March CPI print to “come through” and hit the expected uptick off the back of the “Telco Service” roll-off mathematical boost, likely putting rates / USTs back under pressure

  • Otherwise, further rates rally / short-squeeze will only perpetuate the pain being felt across equities underweights / short-books


The Bund / UST “flight to safety” rally and “seeming” short squeeze is further extended as yesterday’s equities-centric risk-unwind (un-packed in gory-detail below) chops ‘risk’ asset price-action overnight.  Blocks buys in RX earlier which printed at session highs set-up the next level for Bunds looks to be a retest of Dec ’17 contract highs, while TY too clears the 38.2% retrace of the YTD selloff move (121-18 is 50% next level).  Our rates team notes big real money demand overnight and “BIG” receiving flows in the 5Y through 15Y sector.

UST 30Y yields at 3.01 should act as a reminder to investors that YES, ‘long duration’ still works as a “risk off” hedge into this current softer economic growth backdrop, as opposed to the inadequate state of “duration as a hedge” back during the Feb vol spike.  That scenario was driven by the very contrary acceleration in “growth” economic data—especially wage- and inflation- kind--that in turn dictated the fixed-income selloff that drove the behavior which didn’t allow USTs to work as a hedge.  This time truly IS different, it least until the potential for March CPI headline to hit at 2.4% and the “bear raid” on fixed-income will take another “go” at USTs.

To this point, 3m $LIBOR sets +0.6, and despite the insane rally in fixed-income yday (front ED$ a 2.3 standard deviation move relative to 1Y returns), Darren Shames astutely notes that ED open interest STILL barely budged (Whites +36k/ Reds -3k/ Greens +46k/Blues -3.8k).  High conviction from the ‘bearish / paying rates’ crowd, indeed.

Not surprisingly, “growth-y” and tech-heavy Asian equities markets were hit hard overnight, although in pretty ‘sane’ fashion—TOPIX -1.0%, Nikkei -1.3%, HIS -2.3%, SHCOMP -1.4%, KOSPI -1.3%.  USD is only marginally firmer against G10, as the lower UST yields act to drag the currency down despite the “risk-off” nature of the recent trade.  Nonetheless, both Industrial Metals (iron ore -1.1%, copper -0.8%) and Crude (WTI -1.0% after last night’s surprise API inventory build at 6x’s the expected estimate—jarring the recent ‘demand-driven’ bounce theme) are both struggling and also feeding into the lower nominal- and ‘real-‘ yield dynamic that we currently see.

Spooz currently working their way back to overnight session highs with a Shire Pharma bid and a Walgreen’s earnings beat / raise.  But the damage of yesterday will loom for an extended period of time, I’d imagine.


Let’s skip right to the chase: the behavior within particular recent factor- and thematic- “winners” within the US equities space yesterday was so violent / so “tail” that the scale of the drawdown was reminiscent of the brutal market-neutral quant factor unwind period of Jan / Feb 2016.  For the unitiated, that particular episode of whiplash forced a number of heavily-leveraged “platform books” to liquidate around the Street,in turn destroying performance for many over the balance of that particular year, despite an almost immediate “snapback higher” in both relevant factors and broad SPX over the following weeks.

Yesterday was particularly stunning because it occurred with “Cash / Assets” factor--the “biggest factor winner” since July of 2016--which also happens to be the period marking the “cyclical lows” in UST yields before the past nearly two years of grinding higher.  In fact, Nomura’s “Cash / Asset” factor made 5 year lows on June 27th 2016, four days before UST 10Y yields made all-time lows on June 30th, 2016 (point-being, “quant factors” are just another tool to “see” shifts in the fundamental and macro landscape potentially sooner than other traditional methods).

The key here is this, as noted by our phenomenal Quant Strat Joe Mezrich in a piece from mid-February: “Amid the rise in interest rates since July 2016, sectors with high cash/total assets and low debt/equity—tech, financials (ex-banks) and industrials—have also outperformed, while sectors with the opposite characteristics—telecom, utilities, real estate and staples—have underperformed.”  So to me, this factor is an almost “pure” proxy of “Growth vs Value,” which has probably been the biggest theme within the entire equities since the GFC.


Source: Bloomberg

Amidst all the ongoing questions with Tech / Growth “crowding,” the potentially massive regulatory implications of these “New Tech” companies--whose “revenue commodity” is data in the midst of this current #deletefacebook panic—is just simply enormous.  So extremely crowded conditions are met with now “large and slow-moving” regulatory overhang due to seemingly “idiosyncratic risk,” which perversely has now apparently turned into “systemic risk” for the “data” space (see Axios piece today noting a White House acceleration of negativity around Tech universe—both on tax and regulatory).

On top of the ongoing and ugly Facebook situation, you then incredibly “pile-on” with yesterday “short sale” report on Twitter (a stock +47% last year and what had been +33% YTD through Monday’s close) being “most exposed” to a similarly murky “data exposure” scenario, and then the “pure idiosyncratics” of mega-“high flyer” graphics-chip maker NVDA’s -7.8% 1d move (but +26% YTD through Monday’s close) after its involvement in the Uber car crash - while too TSLA (a stock +46% last year) slumped 8.2% yesterday as investors also question their own recent fatal car crash….you simply have the makings for one of the most “freak” blow-ups I’ve seen in my 17 years in the business.

Source: Bloomberg

Many of these companies, as shown by 1Y and YTD returns, are clear “Momentum” longs.  Many of these same companies are clear “Growth” longs.  The two biggest “drags” within the aforementioned and critical “Cash / Assets” factor long blowup yesterday?  TWTR -12.0% and NVDA -7.8%.  Third worst?  ADBE -6.6%, a huge “CLOUD DATA” player.  Fifth worst?  ANET, a “CLOUD DATA” player -6.4% on the day.  I could go on.


Source: Bloomberg


This is where it gets “familiar,” and not in the “good” way.  “Cash / Assets” market-neutral factor experienced a brutal -2.9% absolute move yesterday, which relative to the absurdly high Sharpe of this factor strategy over the last year was an even more amazing -4.1 z-score move.  That is CATACLYSMIC.

Source: Bloomberg

The last time we saw moves that extreme in this pure “Growth” factor expression?  February 5th, 2016—which was the day that still super-crowded “CLOUD DATA” play Tableau Software (ticker ‘DATA’ is the most meta-ironic thing I think I’ve ever seen in my life BTW) absolutely blew the market-neutral buyside to smithereens, as the stock traded -49.4% after a relatively benign “miss” caused a knock-on effect across the “cloud” theme which was an “ultra long” across tech books and growth funds around the Street.

Let’s take a trip down memory lane.  The investor masses by-and-large were set-up “long growth” in equities (Tech, Fins, Energy) / short fixed-income to start the year 2016, after the Fed had just begun their hiking-cycle the month prior in Dec ’15 on the basis of “economic escape velocity.”  Higher rates from “real economic growth” was about to begin, and it was time to get long the stuff that responds in this sort of expansion, against paying rates / short USTs.

However, we immediately saw a BRUTAL mean-reversion / pension fund rebalancing trade to start ’16 as the “deflation scare” absolutely NUKED Tech, Financials and Crude / the Energy space while the “bearish / paying rates” set-up saw “bond proxy” defensives RIP HIGHER as USTs rallied.  The crowded  “growth” trade was absolutely defenestrated then, against a whalloping fixed-income / duration / “low vol” rally…

January 2016 % return:

  • SPY -5.0%
  • QQQ -6.9%
  • SMH -6.7%
  • KRE -12.6%
  • KBE -12.6%
  • XLF -8.9%
  • XLE -3.5%
  • XLP +0.5%
  • XLU +4.9%
  • UST +6.6%
  • TLT +5.6%
  • EDV +8.4%

With this already brutal backdrop in January forcing multi-manager platform team blowouts and book unwinds across this heavily-leveraged equity market-neutral universe (“tight stop” risk management), the Tableau print at the start of February was the straw that broke the strategy’s back, “daisy-chaining” capitulation everywhere.  That lone stock blow-up sent the entire HFR Equities Market Neutral Index -3% in one day!

Source: Bloomberg

What’s the punchline?

 Some people really got hurt yesterday—in a BAD way.  When the buyside goes that know things went “wrong.”


So to be fair, the positioning-angle of this current iteration of the “secular growth” trade has “only’ been this extreme for the past few years—meaning that analogs of prior blow-ups in “Cash / Assets” are not “apples to apples” per se.  But it still matters because this type of volatility, forced “stop-outs” and book capitulations only further weigh on my recent talking point since February, being the “damaged psyche” of risk- / equities- investors, who have been conditioned to ‘buy the dip’ time and time again to their benefit over the past 5+ years.  Now, there is a HARSH re-training occurring, as we’ve clearly transitioned to a TRADER’S MARKET from an EASY-CARRY / HIGH SHARPE / ‘SET IT AND FORGET IT’ one.

The daily stop-outs and drawdowns are also becoming too much for the institutional set, as almost every other day since the start of February, we see “shorts / underweights” outperforming “longs / overweights.”  GROSS-DOWN, again(and FWIW, I think at least part of the reason a lot of this isn’t being expressed purely in Prime Broker data is because so much of the hedging is done via Futures right now, and that data is sitting at Clearing Brokers):

Source: Bloomberg

The issue here is that there is “spill-over” into popular macro and systematic positioning as well:

Source: Bloomberg

So how about the good news first at the SPX-level, which is where cross-asset / macro is going to care.  The analogs dating-back to 2010 of prior extreme drawdowns with this particular “Growth over Value” proxy / theme (that being the “Cash / Assets” factor I’ve concentrated on above) have seen mean-reversion (HIGHER) at the SPX level—take a look at the following data run by my colleague Eric Passmore last night:

Source: Nomura

Now for the bad news—“Cash / Assets” factor typically continues to underperformprimarily due to the outperformance of the “short” leg from here (the “long” basket of “Growth” holds positive with a 60% ‘hit rate’ 2w out and a 50% hit rate 1m out).

So what’s in that “short leg” of the “Cash / Asset” basket which per the analog continues to squeeze painful higher and sap the returns of your ‘long’ leg?

All of the “Value” long stuff, the defensives / duration-sensitives / bond-proxies that nobody owns and frankly makes up the majority of the “Momentum” short as well—i.e. strategies that are running a “mirror” of “Momentum” long-short (broad equities HF long-short) are likely in for more downside chop over the coming month. 

Source: Bloomberg


Source: Bloomberg



Source: Nomura

Below are the case-by-case prior returns since 2010: