In trying to explain today surprising breakout in stocks, some suggested that the catalyst was a VIX triangle formation breakdown shortly after 12pm, when in a rather abrupt move lower, the VIX broke below 14, and below the base of the triangle in which it had been trading since the February vol freakout, with algos immediately reading this as an all clear signal to sell more vol and buy stocks.
Yet while simple and elegant, this theory is also dead wrong according to Nomura's X-asset guru, Charlie McElligott, who in explaining today breakout higher in risk, writes that "it’s much more than a “VIX triangle breakdown”—it’s that ‘inflation’ and expectations of it are the largest positive price-drivers for SPX—more than VIX, more than fwd earnings, more than global GDP growth even."
Specifically, Charlie was watching crude and inflation breakevens - which traditionally follow crude very closely - and notes that when crude breaks out to new 3.5 year highs, and 5y breakevens are back at new 5 year highs, "stocks are going higher as well and forcing people back into the mkt."
Well that, or just buybacks coming back with a vengeance, or just algos feeling extra bullish, but ok, let's assume it is a new burst of inflation expectations: if so, the euphoria will be short-lived as it will mean an even faster rate hike cycle by the Fed and monetary tightening.
Whatever the reason, the Nomura strategist notes that what helped today's move is that many traders still had legacy shorts/underweights in 'deep cyclicals' (energy +2.5% and materials +1.5%) which are seeing violent squeeze, while the big sector pukes into earnings (industrials +1.3% and financials +1.6%) are "ripping off your face as well."
More thoughts in his full note from this morning:
'CYCLICAL MELT-UP' THESIS IN REAL-TIME
- Peak “Cyclical Melt-Up” as my thesis continues to play-out in “real time” overnight: Crude +2.9% / new 3.5 yr highs, UST 10Y Nominal Yields back through 3.00+, 5Y “Real Yields” at new nine-year highs and Spooz at two-week highs
- “Hawkish” Iran deal decertification “event” perceived as the bullish catalyst needed for next leg of Crude rally, as upwards of 200-300k b/d of Iranian production potentially curtailed in an already “tight market” last night’s API inventory draw “beat” as additional ‘bullish’ confirmation into EIA later today
- I’ll say it again: Crude is “the straw that stirs the drink” -> Higher Crude = Higher “Inflation Expectations” = Long Equities “Cyclical Growth”(Energy / Financials / Materials) / Commods / TIPS, Short Fixed-Income / Defensives in this TACTICAL “melt-up” phase
- SPX factor model (per Quant-Insight) confirms this, showing that “inflation proxies” (Iron Ore, Copper, CRB Rind) and “inflation expectations” (both 5Y and 10Y zero coupon inflation swaps) are larger price drivers for U.S. stocks than global GDP growth, 1 year fwd earnings and VIX in the current SPX macro regime
- Additional potential catalyst for inflation? Chinese / PBoC liquidity-boost following the recent monpol “easing” (RRR cut) and fiscal stim (small biz tax cuts), with 7d repo rate making new 1 year lows (high interbank liquidity) and 1s10s Curve steepening to multi-year highs as a “tell” for higher Commodities
- And as a reminder, it’s not just inflation implications (PPI / CPI tomorrow) impacting Rates:
- Today sees a $25B 10Y auction which Darren Shames notes could print the first 3% coupon in nearly seven years
- Heavy seasonal U.S. IG calendar continues with $22B printed already WTD
- U.S. Dollar weakness overnight (predominantly vs G10 as EM still a mixed-bag) should also (near-term) help “hold” Commod gains
- However, the positive “tactical” U.S. Dollar “momentum” backed by 1) ongoing widening in Rates Differentials, 2) multi-year highs in U.S. “Real Yields” and 3) more disappointing global growth data overnight:
- EM data shows Philippine exports print their largest annual decline in 20 months
- Euro (~58% of DXY weighting) earlier new five-month lows overnight after French IP and Manu data weakness (currency has
- In turn, the legacy “long EURUSD” widely held by systematic trend-following CTAs since last year becomes further endangered for “capitulation risk” with likely “sell trigger” at 1.179
- EMFX and equities selloff moderates a touch after the Argentina / IMF credit line news y’day, although sovereign bonds still messy on foreign outflow concerns
- However, ‘Crude’-centric EMs offer some “relative” attraction (Russia, Mexico, Brazil) along with idiosyncratic ‘havens’ (South Korea) on geopol thawing
- USDCNH 6.43 level is another popular “short USD” trade to watch, as Nomura Quant Strategies Tokyo notes it as a potential “capitulation point” from CTAs in trade since late last year, ESPECIALLY as the PBoC cuts the daily reference rate for the Yuan for the 19th consecutive day and to the lowest level since Jan 24th
And some charts of interest—
‘INFLATION’ IS WHAT DICTATES THE CURRENT SPX MACRO FACTOR REGIME:
AS SUCH, U.S. EQUITIES HEDGE FUND L/S MODEL AND CORRELATION TO BREAKEVENS SHOW THAT PERFORMANCE IS LINKED TO A BET ON RATES / INFLATION:
CHINESE LIQUIDITY EASING IS DRIVING A STEEPENING-CURVE AND OFFERING POTENTIAL SIGNAL OF FURTHER GLOBAL COMMODITIES / INFLATION GAINS:
USD RECOUPLING WITH REAL YIELDS AND MARKET ‘HIKING’ EXPECTATIONS