Nomura: Today The Market Landscape Flipped Dramatically "Under The Hood"

There was not one but two odd undercurrents in the market today: it wasn't just the reversal of the sharp, two-day steepening in the Treasury curve (which we previewed earlier) that took place; according to Nomura's cross-aset guru Charlie McEliggott, the U.S. Equities landscape also flipped dramatically “under the hood” intraday and beyond the index level performance pivot, as more notably, there were some very large z-score reversals of YTD trends across the "factor" universe.

Here are the details of what McElligott observed during the trading day, which he believes may have been catalyzed by the surprising announcement of Chinese fiscal easing that hit overnight:

The reversals in questions are many — most obviously a significant “into Value, out of Growth” rebalancing dynamic today (chart below with proxy factors).  As such, “1Y Momentum” is seeing its largest drawdown in a month.  Joining “Value” in classic “late-cycle” fashion is “Quality,” also sharply reversing the YTD trend.

The market cap-based “Size” trend has also been crushed today, with Large Caps outperforming Small Caps  by ~150bps.  So too we see “rebalancing” in more diversified factors, from “Debt / Equity,” “Analyst Coverage,” “Share Buyback,” “R&D / EV,” “Cash / Assets,” R&D / Sales,” “Dollar Dependency” and “Commodities” factors (see the “Factor Categories” monitor below).  

This sort of sharp “mean-reversion” / "rebalancing" / “unwind” is always of interest, as rationally, it acts as an indicator of “performance- / trend- pain.”  

Yet this doesn’t look to be the case today, however, as my model Equities Long-Short Hedge Fund has continued to perform well throughout the session, holding gains of +80bps to +90bps or so since late morning, with my “Short” book driving nearly the majority of the positive performance today. 

So this "mean-reversion" is then "curious" in the sense that on a sector-level, we haven’t seen any sort of change of hierarchy from intraday highs in S&P to the current lows—where generally-speaking, “Cyclicals” have continued to outperform “Defensives,” as they have since the open all day.

As most Quant Strategies are run on a “sector-neutral” basis, perhaps this shows we are in-fact dealing with another “factor unwind” again…but sector-neutral “Momentum” on the day performing is “inline” with market-neutral “Momentum” on the session.  This too in strange, because our “Beta” factor is essentially “unch” on the day (just +0.1%), as is our “Sector Selection” factor strategy (just -0.1%).

In light of the recent high profile underperformance seen with some in the “market neutral quant” space, this is worth watching.  At the end of the day, the timing of this behavior could be the biggest “tell,” and it is occurring into peak Summer illiquidity and month-end timing.  Thus it’s very possible that a multi-strategy quant fund is simply performing a factor “rebalancing.”

Regardless of the source of origin, however, this is a development I am interested in, as it looks to be yet-another “signal” of a regime inflection in the market, alongside “rolling volatility events” YTD and currently spasm-ing central bank policy.  I continue to believe in the larger sense, this is due to the Fed’s “QE to QT” impact as we transition from the late-cycle “Cyclical Melt-Up” stage into the “Financial Conditions Tightening Tantrum” phase—and thus my recent “downshift” view—ESPECIALLY as the “Value” and “Quality” slant is such a “late-cycle” positioning stance.