With Small Caps having broken down to the lowest level since Dec 2020 (down 22% from its Nov ’21 highs) and the rest of the majors testing down towards their March lows, questions abound on whether this is the ‘big one’ or just another dip-buying opportunity?
Nomura’s Charlie McElligott suggests catching this falling-knife may be a decent bet here (for a very tactical trade). By way of background he notes:
Bonds are actually getting a “risk-off” tailwind on global growth scare…
…with the situation in China at risk of metastasizing against a western world which is already fearing “recessionary hard-landing” with CB policy having pivoted so hard to front-loaded “get to neutral” (and possible running outright “restrictive”) policy guidance – on top of monetization flows from crowded downside trades in Rates / Bonds and folks taking shots on tactical longs on “priced-in” Fed on “peak inflation.”
Equities are held hostage by this sentiment thrash by the macros (CB’s and China), with grinding deleveraging evident in fund (out)flows and systematic positioning at extreme lows, with huge hedging demand impulse on the options level and absolute tanking investor conviction due to the “chop” of trying to hold positions longer than 1d – all as the “recession / hard landing” theme builds further conditioning with Low Risk / Defensive leadership seen over the past month.
But as we hit the low end of the year to date range trade and looking across the aggregate of inputs, McElligott suggests the ‘pros’ for building a tactical Equities long / buying the pullbacks over the next two weeks of event-risk clearing (Earnings “kitchen sinking” from Corps and Fed hawkish hike) are mounting:
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extreme “negative Delta” in options positioning (against “short Gamma”) and Vol finally outperforming on “overhedging” both “set the table” for an Equities rally, when Vol eventually collapses under the weight of its own implied moves;
This short-term trading suggestion fits with the 2008 analog we have been following with interest and perhaps will result in a ‘sell the news’ moment when The Fed hikes 50bps (or 75?) in May…
But, the Nomura strategist does offer some level of sanity check:
Caveats for this “leg-into Bullishness” are of course:
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any further upside inflation surprises which risks more central bank hawkishness;
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big Tech earnings and the risk they’d “kitchen sink” it;
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plus, the potential that the negative price-drivers in the QI macro factor model (Corp Credit and Risk Aversion) nullify the “cheap to FV” signal, especially as the model confidence is trending lower and towards the “no confidence” r^2 of 65%.
And an additional potential headwind from the “real money” set…is that Global fund flows are probably the driver from here, with EPFR data showing the recent outflow story getting more acute, after an eye-watering +$1.3T of Equities fund inflows since 2020…
Translation: rent the market long, don’t marry it!
