Nomura: Stocks Begin Their Re-Correction; Watch Out Below 2,600

Has Nomura's cross-asset strategist, Charlie McElligott done it again: after calling the market's last two inflection points, did he time the latest market mini peak to the day?

Readers will recall that one week ago, when sharing his tactical perspective for the immediate future, Nomura's strategist - referring to the bank's Sep 2018-Jan 19 S&P “comp” to the Oct 2007-Oct 08 analog...

... predicted that Friday could mark a “local high” in the SPX before resumption of a -5% selloff over the 9 sessions thereafter, before then commencing another extended rally thereafter (see day count table below)

So far so good - again - because after a weekend in which all the recent rumors about an imminent US-China trade deal were appropriately squashed, global markets have started this week deep in the red, with US equities set to follow today. As a result, in his latest note, McElligott warns again that he sees "scope for Spooz to revisit 2525 level over the next two weeks" (spot last 2655) as tactical longs are "turning SELLERS after hitting targets last week and Systematic Trend now far from “covering trigger” levels" (even so, the cross-asset strategist has a stop-loss +2.5% in S&P futures ~ 2720 which coincides with the 61.8% retrace of the Sep high / Dec low range).

For those who missed last week's note explaining McElligott's rationale for calling the top, the strategist repeats that his call is the result of tracking the "2007-08 analog" which allowed Charlie to "mark this past Friday Jan 18th as the “local high” in SPX—while today is now either in the first or the second day (depending whether you include Monday’s partial session) of the ensuing nine-day correction (Day 20 or 21 in the table) in US Equities, which should then make a “local low” around Jan 31st / Feb 1st" before breaking out on another multi-week bear-market rally thereafter, catalyzed by the return stock buybacks on Feb 6. Quoting this past Wednesday’s “The Pause…that Refreshes” note which we laid out here:

“…from a “tactical sequencing” perspective, our Sep 2018-Jan 19 S&P “comp” to the Oct 2007-Oct 08 analog (highest correlation btwn current environment and prior “trigger dates” of -17.5% SPX selloff in 67 days or less) would suggest that Friday (my edit: this past Friday Jan 18th) could mark a “local high” in SPX before resumption of a ~-5% selloff over the 9 sessions thereafter—before then commencing another extended rally thereafter”

For those who don't believe in charts, Nomura also lays out a fundamental case for a US equities tactical trade lower as we have already "squeezed the maximum amount of blood from the stone” of the three qualitative macro catalysts noted previously when CME made the tactical “bull” call the third week of December. Nearly a month later, those catalysts which prompted the short-squeeze and bear-market rally have already been almost fully “realized”:

  • The Fed cannot pivot “more dovish” without a major degradation of US data, while “QT” powers-on undisturbed despite the predictable “forward guidance” rhetoric from Fed speakers that they are open to adjusting if required;
  • The PBoC “spasming” further escalated with last week’s liquidity-injections, fresh tax cuts and “special bonds” for infrastructure flurry—yet no true “nuclear” option yet  via rate cuts and deregulation of property markets;
  • And finally, “positive leaks” from the US / China trade negotiations reached their zenith last week, with the two stories trial-ballooned regarding the story on Treasury Sec. Mnuchin’s willingness to ease tariffs and the Chinese offer to close the trade gap by 2024 -stories either being outright denied or met with skepticism from US trade sources

Meanwhile, the high frequency economic data has been screaming imminent meltdown ever louder: i) The Bloomberg China Economic Surprise Index has dropped to lows not seen since Feb 2016 while the Citi Surprise for Asia Pac is at lows since Mar 2016...

Meanwhile, the ECRI US Weekly Leading Index Growth indicator YoY 4 week moving average is at nearly 7 year lows.

Next, focusing on McElligott's bread and butter, namely tracking "flows", he notes that whereas previously there was the danger of a major short squeeze, this has now passed as flows have "corrected", and the prior “under-positioning” from Systematic Trend has been moderated as "Max Shorts" have reduced, and  in the case of recent “tactical longs” some are already selling recent gains and taking-profits:

  • The critical “tie-breaker” flows of the short-term Systematic Trend / CTA community have already adjusted their prior “Max Short” in Global Equities which was built across December 2018, yet since reduced in scale / short-covered and contributing to the powerful rally in Stocks since Dec 24th
  • Now, those positions currently sit ~ “-87% Short” instead, with no further covering to be triggered without a very significant move higher—as it stands today with levels held “static,” next CTA cover in SPX would not occur until we close above ~ 2728 in SPX…meaning CTAs are in “no man’s land” here and effectively “out of the picture” / no longer generating “buy cover” flow
  • A few notable technical traders have made calls since Friday calling to take profits on “exhaustion” of the rally and expecting another correction-phase

Similarly, the S&P index options delta-hedges, i.e., "Greeks", are likely to accelerate any S&P move below 2600, turning "short gamma" the further we move below 2600:

  • Importantly, SPX / SPY consolidated options “greeks” have too now pivoted “bullish” with Net Delta ripping positive (from -$26.5B to now +$197.6B), with Gamma now +$9.5B per 1% move—meaning that dealers will likely generate counter-cyclical flows to keep market “pinned” at strikes north of 2600
  • “Net Gamma” again pivots NEGATIVE, accelerating below 2600—which means there is a risk on a break below that dealers will be forced to accelerate selling the lower we go

Finally, and as noted above, this is merely a tactical short, with the next leg expected away from this “bearish tilt” expected to hit at the start of February, as the resumption of the corporate buyback bid commences largely after Feb 6th with 75% of SPX out of the “blackout” period, and pushing equities higher for the next several weeks as the Lehman analog plays out.