One day after the midterm elections, when the Dow soared by over 500 points on abysmal volume, the formerly bearish narrative immediately turned to how wonderful gridlock is for stocks, with Wall Street suddenly certain that based on historical patterns – according to which the market has levitated into year-end every single time after midterms – this year would be no different.
So much for certainty: as of today, all the post-Midterm gains are gone…
… and the market has resumed its downtrend, down 6% since October, compared to a 10% drop for the Nasdaq as tech stocks got liquidated en masse as sentiment has once again sharply turned against anything that has to do with growth.
Alongside the seemingly random liquidation in the tech sector, investor fears are rising, manifested not only in slumping prices but also in the surge of the 30-day vol in the Nasdaq 100 which according to Bloomberg has tripled in five weeks, rising to the highest since 2011. As a result, day-to-day swings are now averaging 1.7%, half a percentage point more than in February, as prices for options protection in tech have exceed the rest of the market by the most in seven years, using the difference in implied vol between the Nasdaq and the S&P 500.
But while there were many immediate reasons for today’s 600 points plunge in the Dow, including the surge in the dollar to fresh 2018 highs, the guidance cut and a warning from a key Apple supplier confirming that iPhone demand is tumbling, fears over rising rates, political turmoil in Italy and uncertainty over Brexit, slowing profit growth and rising negative earnings pre-announcements, the unspoken catalyst behind today’s mass dump most likely has to do with the previously discussed November 15 mass redemption day faced by hedge funds, one which we said portends a November 15 bloodbath as underperforming hedge funds brace themselves for an avalanche of redemption requests. And all this happened as bond markets were on vacation, further accentuating the already illiquid equity moves.
Confirming this, Nomura’s Charlie McElligott wrote after the close that what was already a sloppy situation within the U.S. Equities-space “got even messier, as the (negative) performance-driven de-risk / “de-gross” of the past month has escalated.” Specifically, today saw a “somewhat idiosyncratic” set of circumstances “pile-on” into the already-stressed environment surrounding the imminent HF “redemptions notice” date, accentuated by the following “death by papercuts” factors in stocks:
- The 5% implosion of Apple and its supply-chain following LITE’s guidance-slash on “meaningfully reduced shipments” from one of its largest customers (-30.3%), implicating Apple and reduced demand for iPhones. The news crushed the entire supplier space (AMS SW -22.4%; CRUS -13.8%; KN -10.2%; AMD -9.4%; SYNA -8.2%; IFX GR -7.1%; AVGO -6.4%; STM IM -6.4%; QRVO -6.3%) as the three-year “hiding place” in the Apple phenomenon breaks-down.
- The ongoing destruction in “Growth”-heavy long portfolios (“Cash / Assets LONGS” are -3.8% on the day, “R&D / Sales LONGS” -2.9%), as well as large gains in “Value” market-neutral strategies, where despite actually somewhat lower “Value LONGS” on the day, the Growth companies which make up “Value SHORTS” in the market-neutral factor strategies are being crushed—e.g. “EBITDA / EV SHORTS” are -4.1% today, “Predicted E/P SHORTS” -2.4%
- Another unwind of popular hedge fund positions has to do with the de-betaing of portfolios in a hurry: “beta longs” are -3.1% on the day, and -15.8% QTD, the result of unwinding “long high beta, short low beta” bets, which has rationally corresponded with the Equities L/S hedge fund performance swoon, as it captures that many funds were long-er the market than they realized
Factors showing the pressure on popular “growth” longs are captured by the upside for “Value” Market Neutrals (as shorts are squeezed) and the selloff in “beta” and “vol”:
Equities HF L/S index ticking with real-time “beta” factor market neutral-i.e., funds’ market exposure was even higher than realized:
Meanwhile, as we noted in our EOD wrap, the market has dropped enough to where dealer gamma imbalance is back as a downward market force, with further stock declines forcing further liquidations in a self-reinforcing loop.
Additionally, according to Nomura there is another important mechanical phenomenon, where an important “rally date” falls out of the 1m sample set (by today’s close) from the bank’s systematic trend model, which means -$32.8B of S&P futures for sale on a close and sending the overall allocation in S&P from “100% Max Long” back down to just “65% Long.”
In practical terms, this is the case for 1) Nasdaq, with this date falling-out dictating a deleveraging from “100% Max Long” down to “65% Long” and creating -$21.6B of selling in NQ1 and 2) Russell 2k, where the close below 1545 sees the “65% Long” decline to “30 Long” and create -$17.4B for sale in Russell minis.
Meanwhile, in addition to the stunning 8% drop in Goldman shares, largely the result of rising concerns over the bank’s (and Lloyd Blankfein’s) exposure to 1MDB, McElligott also highlights his long-time “funding stress” proxy whipping-boy General Electric is back under the gun (-6.3%) after the CEO flopped in his TV debut.
The final insult to injury within U.S. stocks was the S&P Energy sector sliding -2.2% as Crude couldn’t hold positive and was smashed -2.5% lower despite the OPEC supply cut jawboning this weekend, with President Trump tweeting at the Saudis along with the US Dollar breakout further challenging oil.
It wasn’t all gloom: the Nomura cross-asset strategist notes that, hilariously, the “Buyback” factor was one of the best performers today +0.9% / +1.7 SD’s (1Y relative), indicating that the corporate bid is one of the few supporting phenomena in the market. However, not even buybacks were strong enough to prop up the market from today’s bloodbath.
Putting the above together, McElligott cautions that even with a brief selling pause provided post the passing of the November 15 hedge fund redemption date, this “death by papercuts” market is further sapping willingness to deploy risk despite a “cleaner” positioning footprint and the return of the “buyback bid.”
These “papercuts” only add to the already damaged psyche of investors, who are clearly in the grips of the “glass half-empty” view that the Fed is on the “policy error” route and will “tighten us into a slowdown.”