Why September Will Be A "Tale Of Two Halves"

Two weeks after Nomura's Charlie McElligott noted that he was observing "a multi-month performance disaster for US equity funds", as a result of hedge funds getting caught offside by yet another vicious short squeeze, coupled with low net leverage and beta exposure, and insufficient exposure to "momentum" stocks, the cross-asset specialist writes today that as part of the call to get long “Momentum” factor in U.S. Equities (which finished August +9.5%), Hedge Fund Long-Short funds have “grabbed” at market exposure, with the bank's internal metrics showing that L/S funds took up their “Beta to the S&P” to the 100th %ile, in large part thanks to ripping “Momentum Longs”, noting that the "beta to Mo Longs” now 96th %ile, from 44th %ile a week ago."

At the same time, the broader Asset Manager category has also been "grabbing" at SPX as expected off the multi-month performance drag, adding a monster +$13.9B of S&P futures last week.

This has helped the Hedge Fund HFRX Equity Hedge Index regain some ground in the second half of August, although even with the recent rebound the index is still barely changed YTD and sorely underperforming the S&P500.

And while we noted yesterday that the post-Labor Day period has traditionally meant smooth sailing into the end of the year, with the S&P yet to post a decline in the last 4 months of the year, some are becoming skeptical, and as McElliggott writes, just as the rest of the hedge fund space is levering up for the "momentum" chase, macro funds are are reducing their exposure to “risk-proxies” here:

Equities exposure shows Macro fund “Beta to SPX” at just 4th %ile (cut from 32nd %ile); “Beta to Nikkei” 36th %ile; “Beta to Eurostoxx” at only 1st %ile and “Beta to EEM” at just 1st %ile as well

Macro is also selling the bounce in Crude, with “Beta to CL1” cut to 38th %ile from 50th %ile

Yet having correctly predicted the sharp move higher amid the performance scramble in late August, the Nomura strategist now warns that "due to the massive +++ PNL move in “1Y Momentum,” I am now getting much more tactical", and makes the following derisking recommendations:

  • I have now taken-profits on 1/2 of the trade and will continue to reduce exposure as funds clearly “pre-positioned” into Sep seasonality / “window dressing” phenomenon
  • I will likely keep on the “Short Momentum Shorts” leg into the back-half of September, as there is historical weakness in “High Beta” / “Volatility” (while “Low Vol” / “Defensives” rally in the final two weeks of the month)

Last, but perhaps most important, is McElligott's observation that September has a distinct calendar pattern to it, with equities set-up for a "rally in front half of month, sell off in back half", as shown in the chart below.

What would catalyze such a move this time? Why the same positional rotation that prompted the furious August rally:

Funds “forced-into” the melt-up at start of month / +++ historic for the first two weeks, just before post-expiry dealer gamma comes off and the “buyback blackout” picks-up for many of the largest S&P sectors.

This is what the seasonal performance for September has looked like over the period 1994-2017.

And some more details on why September is a "tale of two halves": "Risk on" from 9/1 TO 9/15 before seeing a defensive reversal over the final two weeks of September:

Finally the "1Y momentum" algos also appear to be aware of this September calendar quirk, and have traditionally exploited the performance: