RBC: “It Is Crazy What Is Going On ‘Under The Hood’ When On The Surface It’s So Optically Calm”

Having cautioned that the economic macro surprise rally of the past three months…

… has been mostly based on the back of “soft data” surprises, in other words, hope and moistly animal spirits, which “are driving the bulk of the US data surprises”…

… today, RBC’s head of cross-asset strategy Charlie McElligott looks at the first sharp selloff, coupled by a vol spike and observes that one week after the first Trumpflation jitters, the Trump trade on Monday appears to be losing policy momentum, and as a result “profit-taking of longs ensues.”

As McElligott notes, it has been an agitated market to start the week, with VIX seeing its largest intraday move so far in 2017 as we see thematic winners of the past three months being unwound.

It’s not a puke just yet, as we are “still not getting that ‘FTQ’ bid we’d come to expect in the old “risk-OFF” regime, with USTs (and Dollar) essentially unch.  This says to me that it is STOCKS which have discounted the most +++ inputs of potential Trump policy (see last Wednesday’s price-action), and is thus the most ripe for a re-pricing of his ability to ‘steady the ship’ with suddenly-waning policy momentum.“

The good news for bulls hoping that BTFD will quickly reemerge, is that much of this move is long overdue, and is likely not the precursor of a sharp move lower:

“today’s story feels much like that overdue selloff with nervy profit-taking and some recent risk “renters” tapping quickly on tight-stops.  From a ‘sustainability of the drawdown’ perspective, this quick blast of volatility off of a historically low-base isn’t enough to trigger much if any mechanical deleveraging from the mechanical ‘vol control’ community in-and-of itself, with 20 day S&P historical vol still sitting (laughably) with a 7-handle.”

Unless, of course, it is.

So what does the RBC strategist say to expect from markets in the coming days? The following 4 points summarize his views:

1) Stocks—much more so than FX or rates—are the asset-class bearing the majority brunt of this weekend’s chief geopolitical consternation.  It ‘seems’ that the discombobulated implementation of Trump’s immigration orders has ‘furthered’ the market concerns on protectionism and the potential for Trump’s usage of “executive orders”  to have “jumped the shark” just a few weeks into his tenure.  The growing list of fellow-Republicans lashing-out at the immigration order—as well as the obvious lack of cohesion with the messaging even with the Trump administration–are raising concerns on ‘lost momentum’ with regards to what the stock market really wants from POTUS: tax policy clarity.  As stocks have been the area “quickest” to discount expectations of lower corp tax rates, they “wear it” when markets now begin to reprice Trump’s ability to “get deals done.”

As has been stated over the past week in “RBC Big Picture” there is now growing speculation that the tax plan won’t be clarified until well through the Summer (Reuters this weekend http://reut.rs/2kFdaSF), especially as the ‘funding’ side of a BAT remains yet to be seen—which means it currently isn’t ‘revenue neutral’ which is a demand from many GOP lawmakers.  As forward earnings estimates are increasingly-contingent upon the ‘corp tax rate cut’ and ‘dereg’ components of his policy, there is thus mounting nervousness about recent buyers at all-time highs in US stocks turning tail (note: Asset Managers are now notionally long $80B of US equity futures , making year-and-a-half cumulative highs) if ‘reality’ weren’t to meet the heavy ‘expectation’ on policy which has been incorporated into current pricing.

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2) Today’s particulars show something interesting: both the thematic “reflation” and “Trump winners” (most clearly expressed in 4Q16—border tax beneficiaries, dereg beneficiaries, infrastructure beneficiaries, security beneficiaries, domestic-gearing beneficiaries) and 1Q17’s “mean-reversion” leaders are under pressure.  This means that today we see both the “‘cyclical beta’ / ‘small cap’ (large IWM downside trades today) / ‘value’ / ‘high beta’” cohort is trading-off IN CONJUNCTION WITH “‘secular growers’ / ‘momentum’” Q1 leadership selling-off as well (tech sector specific concerns on H1-B impact for workers).  What is working should of course not surprise: ‘low vol’ / ‘quality’ / ‘defensives’ / ‘anti-beta.’  Basically, longs are being sold while shorts are added / pressed—thus, today is NOT a ‘gross-down’ or ‘wholesale de-risking’ day.  

Less tactically / away from the ‘now’ of today’s ugly tape…

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3) As has been discussed since mid-December—when anticipation of a “January Effect” saw funds putting on “reversal strategies” in equities factors earlier than usual—“Growth” and “Momentum” factors have been significant outperformers, with both leading all factor market-neutral strategies YTD.  The interesting thing here is that this comes following 2016 where “Growth” and “Momentum” were the two worst-performing factor m/n strategies YTD…confirming another victory for the January mean-reversion strategy.

More granularly, the performance of “Growth” has helped drive the large YTD gains in Tech and Consumer Discretionary sectors against lagging (former high-flyer) “Value” and “Anti-Beta” factor m/n (representing cyclicals and defensives, respectively).  The performance of 1m “Momentum” factor m/n would reasonably reflect this same “Growth vs Value” reversal, as ‘momentum longs’ are led by Tech, Materials (S&P’s best performing sector YTD), Consumer Disc and Industrials, while ‘momentum shorts’ are heavily represented by Cons Disc as well as Healthcare, Tech and Energy (S&P’s worst performing sector YTD, after being last year’s “value” darling). 

This also highlights the significant move higher in dispersion (or correlation breakdown) as we see sectors representing across both momentum leaders and laggards.

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4) On that note, an interesting anecdote picked-up from an astute client and friend this weekend regarding the extreme nature of increasing single-stock dispersion currently being experienced in the market-place, which I will paraphrase: “For over the last month plus, watching our portfolio grind higher it feels like 10- to 20- some basis points on the majority of days, which seems kinda sleepy…but when I look at the individual names in our long and short books, I am seeing HUGE moves daily.  Both books at times are riddled with many stocks seeing 2 and 3 standard deviation moves….it is CRAZY what is going on “under the hood,” when on the index level, it’s so optically calm.” 

Idiosyncratic stock-risk is returning, and that is a sign of a market normalizing from years of central bank volatility suppression = score one for active management.

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While that would be great news for hedge funds if true, we look forward to learning from bulge bracket prime brokers in a few days time if hedge funds finally managed to outperform the S&P, or if 2017 has started off in familiar fashion, with the “smart money” once again nothing but heavily levered beta.