Here Comes The Selling: CTAs, Dealer Gamma Flip Short Today

For weeks, the market "inexplicably" continued to levitate even as investors relentlessly redeemed equity funds, a move which BofA said on Friday was "solely driven by corporate buybacks/derivative call buying/short-covering/ retail single stock buying." All of that is now ending, especially with buybacks set to end for the next month now that the Q1 earnings blackout period is upon us.

And following Friday's violent rout, which sent the S&P back to 2,800, the trader calculus has changed drastically according to Nomura's Charlie McElligott (who is so far winning the quant feud with JPM's Marko Kolanovic).

Commenting on Friday’s “growth scare” spasm, the Nomura strategist says that it looks to have set-off widespread portfolio/strategy rebalancing, following the brutal global economic data (Euro PMIs contracting alongside US Manu/Services/Composite PMI “misses” as well) — and which then saw wholesale inversions throughout the US front-end as palpable “recession” risk was reintroduced to the “market-psyche."

This “acceleration towards the end-game” - which will eventually force the Fed to cut rates not by 25bps but unleash a 50bps easing bazooka - drove a powerful mean-reversion in Cross-Asset Risk Premia, as many crowded “YTD winners” saw large blasts of monetization / “size-down,” while “losers” were much more nuanced, specifically within US Equities, many shorts were pressed/grossed-up to hedge on the selloff, "although we did see a very-obvious “up in quality” defensive-type shift as well, with “Beta” (US Eq “Beta” factor L/S largest 1d drawdown since Brexit June 2016) and Small Caps (bottom-five worst 1d return in RTY since Brexit June 2016) “purged” vs a grab into “Low Vol” / Bond-Proxies.”

The bigger point, as McElligott recaps, Friday was not a simple “de-risking” trade in US Equities — but instead it was a wholesale portfolio rebalancing/rotation which saw "tremendous" thematic-/sector-/factor- performance-dispersion as follows:

  • US Equities “Beta” factor -4.4%, the largest one-day drawdown since 6/27/16 (post-Brexit vote)
  • US Eq “Volatility” factor -4.1%, the largest one-day drawdown since 10/24/18 and second-largest since Brexit
  • US Eq “PEG” factor (Growth) -2.1%, the third-largest one-day drawdown since 5/3/12, ‘bottom 5’ worst day since 2010
  • US Eq “Default Risk” factor -2.0%, the largest one-day drawdown since 1/22/19 and fourth-largest since 5/24/17
  • US Eq “Commodities” factor -2.1%, worst day of 2019
  • US Eq “Predicted LTG” factor (Growth) -1.7%, worst day of 2019
  • US Eq “Analyst Coverage” factor -2.0%, 2nd worst day of 2019
  • US Eq “Cash / Assets” factor (de facto “Growth vs Value”)  -1.8%, the third-worst day of 2019
  • US Eq “Volatility Adjusted Momentum” factor +1.6%, best day of 2019
  • US Eq “Dividend Payout” factor +1.7%, 2nd best day of 2019
  • US Eq “ROIC” factor (Quality) +0.9%, 2nd best day of 2019
  • US Eq “ROA” factor (Quality) +1.0%, 2nd best day of 2019
  • US Eq “Debt / Equity” factor four-day return (+2.1%) the largest since the four-session period ending 3/7/16

The rotation wasn’t restricted to just to US stocks, as we saw massive moves in Cross-Asset Risk-Premia on Friday as well, and which continued on Monday with Asia's biggest drop of 2019.

Making matters worse, many of the YTD gains for the active investing community were wiped out in just a few hours as Friday’s violence was particularly notable via powerful selloffs in 2019 YTD winner “Carry” strategies, with -2 to -3.5 z-score  drawdowns in Credit- and Currency- “Carry,” while not surprisingly,  Interest Rate Volatility “Carry” was hit the hardest in light of Friday’s blowout / reversal in the US Rates vol surface. At the same time, the 2019 YTD Cross-Asset Risk-Premia loser “Momentum” benefited from 1) the return of Vol and 2) the flattening / inversions in front-end curves.

Enough about what already happened: what traders wants to know is what happens next?

Here, the bigger problem is that many of the supports of the biggest rally to start the year since 1987 are rapidly falling away, with arguably the most important of these, the "long gamma" positioning by the dealer community - which as McElligott notes helped "pin" the market at 2,830-2,840 - now sharply reduced, with spot S&P nearing the point where dealers will flip "short gamma", and where selling will become the default mode of the market.

But wait, there's more: because just weeks after they were forced to turn bullish, Nomura's CTA model estimates that the Russell trend-followers will "flip short" by the end of the day, of course barring a large rally. Specifically, Russell 2000 CTAs, currently 50.4% long, will sell and flip to short under 1536.21 to get to -100% short; alternatively expect buying over 1578.57 to get max long.

This is due to the phenomenon Charlie has been discussing in the past two weeks w.r.t. the mechanical pulling higher of sell-triggers in conjunction with Friday’s selloff through said “sell” level.

For those curious - which would be most traders desperate for key buy/sell trigger levels - McElligott also posts his latest cross-asset systemic trend "trigger" level breakdown, where the big highlight here is that in addition to selling in the Russell, CTAs - which are currently "100% long" the S&P500 - are about to start selling the broad index, should it close at 2.777.31 today, cutting their long positions in half.

  • S&P 500, currently 100% long, selling under 2777.31 to get to 50%, more selling under 2636.65 to get to -100% , flip to short under 2636.93, max short under 2636.65
  • NASDAQ 100, currently 100% long, selling under 7048.5 to get to 50%, more selling under 6677.31 to get to -100% , flip to short under 6678.05, max short under 6677.31
  • Euro Stoxx 50, currently 100% long, selling under 3175.37 to get to 50%, more selling under 3026.85 to get to -100% , flip to short under 3027.17, max short under 3026.85
  • HangSeng CH, currently -50% short, more selling under 11311.46 to get to -75%, max short under 11310.31, buying over 11712.02 to get to 100% , more buying over 11710.87 to get to 25% , flip to long over 11710.87, max long over 11710.87
  • USD_10Y, currently 100% long, selling under 121.32 to get to 28%, more selling under 118.8 to get to -100% , flip to short under 118.81, max short under 118.8
  • EUR_10Y, currently 100% long, selling under 160.82 to get to 28%, more selling under 156.67 to get to -100% , flip to short under 156.68, max short under 156.67
  • GBP_10Y, currently 100% long, selling under 122.37 to get to 28%, more selling under 119.56 to get to -100% , flip to short under 119.57, max short under 119.56
  • EUR_10Y, currently 100% long, selling under 160.82 to get to 28%, more selling under 156.67 to get to -100% , flip to short under 156.68, max short under 156.67
  • EURUSD, currently -100% short, buying over 1.1496 to get to -58%, more buying over 1.2671 to get to 41% , flip to long over 1.2671, max long over 1.2671
  • USDJPY, currently 16% long, more selling under 102.4307 to get to -41%, flip to short under 102.4307, max short under 102.4197, buying over 110.4216 to get to 58% , more buying over 110.4316 to get to 100% , max long over 110.4316
  • GBPUSD, currently -16% short, more buying over 1.4352 to get to 41%, flip to long over 1.4352, max long over 1.4354, selling under 1.2706 to get to -58% , more selling under 1.2705 to get to -100% , max short under 1.2705
  • AUDUSD, currently -100% short, buying over 0.7091 to get to -58%, more buying over 0.7694 to get to 41% , flip to long over 0.7694, max long over 0.7694
  • USDCNH, currently 16% long, more selling under 6.3912 to get to -41%, flip to short under 6.3912, max short under 6.3905, buying over 6.9267 to get to 58% , more buying over 6.9274 to get to 100% , max long over 6.9274
  • WTI, currently -13% short, more buying over 59.61 to get to 8%, flip to long over 59.61, max long over 68.32, selling under 57.4 to get to -30% , more selling under 57.39 to get to -46% , max short under 44.0
  • Gold, currently 23% long, more selling under 1261.94 to get to -3%, flip to short under 1261.94, max short under 1210.07, buying over 1327.8 to get to 40% , more buying over 1327.94 to get to 56% , max long over 1386.93
  • Copper, currently -46% short, more buying over 6319.94 to get to -11%, flip to long over 6320.57, max long over 6552.16, selling under 5960.89 to get to -73% , more selling under 5960.26 to get to -100% , max short under 5960.26

Finally, recall that last Thursday we posted "Battle Of The Quants: Kolanovic Counters McElligott With 6 Reasons Why It's Time To Buy." Considering that the very next day saw the second most brutal selloff of 2019 and one which if McElligott is right will continue for a while, it is safe to say that we will not see any updates from the JPM quant until the next major market uptick.