‘A Strange Game’… Nomura Asks, Is This Market “Untradeable”?

US equity markets have trodden water, in an admittedly wide range, for the last two weeks as the substantial two-week rally kicked-off by the absurd “September Fed Pause” meme which peaked at the end of May, has now seen the resumption of the first index/ETF “hedging demand” in a while over the past few days, despite the ongoing melt in “Vol of Vol” with VVIX breaking 90 yesterday.

As Nomura’s Charlie McElligott succinctly points out is a note this morning, Equities positioning is a DOOZY of recent movement…

What is remarkable is that despite such a powerful and large covering of “Short $Delta” off the lows across major US Equities index / ETF Options from the recent Spot rally and Vol crush = Put destruction (+$465.3B off the 5/13/22 morning 0.0%ile lows in SPX / SPY consolidated $Delta alone), Delta positions remains “Negative” in SPX / SPY, QQQ, IWM as well as for everybody’s Credit hedges in HYG and LQD

• SPX / SPY $Delta -$248.8B, 7.9%ile

• QQQ $Delta -$13.5B, 8.4%ile

• HYG $Delta -$9.8B, 3.1%ile

• IWM $Delta -$7.3B, 17.5%ile

• LQD $Delta -$2.5B, 33.1%ile

On the ‘micro-side’, the Nomura strategist notes that the news that big-box US retailer Target is cutting their profit-outlook AGAIN for the second-time in weeks – which speaks their amassed inventory issue and unusually high transport / fuel costs crunching their margins – is again turning the focus back to the devolving Corp Earnings / Margins environment, in the new age of:

1) post-COVID over-ordering “bull-whip” effect,

2) wonky supply-chain disruptions and

3) the ongoing inflation impulse, as well as

4) further debate about the status of the consumer.

On the macro-side, McElligott notes his expectations of a renewed ‘hawkish impulse’ which will prompt another ‘Financial Conditions tightening’ impact yet-again, arresting Equities rally and Credit Spread tightening, while also driving US Dollar higher too.

This would fit with McElligott’s ‘market cycle’ chart that explains why we remain rangebound here…

The Nomura strategist concludes by noting that there is still an enormous size of legacy “Puts over Calls” into next week’s MASSIVE Serial / Qtrly Op-Ex, which means there is potential for significant inflection coming-out depending on what investors do with resetting hedges or letting them roll-off.

SpotGamma reiterates its view that rallies into June OPEX should be categorized as “short covering” and subject to failure, with with support at 4100 then 4063 and resistance at 4150-4160.

Below 4100 level we see an increase of negative gamma, which implies an uptick in volatility. 4000 remains critical support into OPEX, and we do not see that level being tested today. However, as SpotGamma opined on Friday the lift from traders being able to sell volatility will diminish into week end, which implies reduced support.

McElligott’s point is that Vol seems “cheap” here, especially into a MASSIVE “binary” CPI / FOMC / VIXpery and Op-EX 1 week window!

Perhaps the message, however, is that this continues to be a market is so “untradeable” (despite low Nets and Gross) that the old conditioning of “chasing returns” just isn’t incentivized when you’re down like this and markets continue seeking the points of max-pain.

So, what changes that? 

Perhaps 3 consecutive months of Inflation data moving sustainably lower, which would then see Fed hiking expectations ratcheted down in “dovish” fashion; or conversely, maybe it is an FCI tightening that sees PMIs push back into “Contraction” territory, or multiple “negative” NFP prints in a row which in a different manner, make the same “dovish” signal to markets – but with a more ominous “Cycle” message.

So, hedges will continue to screen “cheap”… but that is a function of an environment where there simply is not conviction / willingness to take your underlying core exposure back-up in meaningful fashion ahead of MONTHS of such economic data volatility, which will continue seeing “reactive” Central Bank behavior, that will mean illiquid and volatile trading price-action behind it all…