One week after RBC's Charlie McElligott pointed out that the "someone is going to get hurt badly" in the upcoming clash between leveraged and real money investors in 5Y bonds, whose divergent opinions on the future of interest rates, and thus inflation, has reached record levels...
... and was was picked up overnight by Bloomberg, today the cross-asset strategist focuses on something broader, namely the creeping rotation out of consensus reflation trades, driven by "concerns surrounding Trump’s ability/willingness to implement a “border-adjusted tax” system" which was at the core of much of the USD appreciation.
So is it time to finally "sell the inauguration"?
Below we lay out McElligott's latest thoughts with the rotation picking up steam, as the USD weakens further:
* * *
Today shows continued paring-back of “consensual reflation” trades that dominated performance tables in 4Q16, with the Bloomberg USD Index being the largest z-score mover in all global Forex markets today (-1.25 z vs 90 day return). The ongoing concerns surrounding Trump’s ability / willingness to implement a “border-adjusted tax” system” is at the core of this, because it was at the core of much of the USD appreciation thesis. In turn, as highlighted a week and half ago, we’re seeing popular ‘reflation’ trades under pressure. Posit my “crowded trade” and “risk thermometer” monitors, each sorted by the prior 3m return (and the opposite intra-day performance):
STILL GOING:
ONGOING WONKINESS WITH POPULAR TRADES: Certainly more of a mixed-bag on the ‘short’ side…but no doubt seeing PNL whipsaws over the past week +.
Since I highlighted the US Dollar as “the single-largest macro input risk to the buyside” in the “Big Picture” morning note Jan 11th, the two most-common trade-weighted USD indices are both down ~1.7%. Over that same period of time, so too are the many popular thematic “reflation” trade expressions (many of the same trades as highlighted above): ‘small cap’ equities, ‘high beta’ equities, ‘early cycle’ stocks, equities ‘value’ factor, ‘cyclical beta,’ ‘cyclical vs defensive’ pairs are all LOWER in concert.
(The same too can be said of popular macro trades built-around the same “long Dollar / long reflation” framework, where we also see similar reversals off the back of the USD-unwind since the highs on Jan 11th: for example, consensual macro shorts in Euro, Yen, EMFX, EM equities, Gold and VIX are all higher over this period.)
This said, the USD’s pullback has not stopped leveraged funds from pressing their “reflation shorts” in USTs over the past few weeks, as we’ve seen yields turn modestly higher again off continued strong data YTD. Essentially, the US Dollar and Rates have diverged recently, which will need to be reconciled sooner than later. It is now clear that some of the tactical spec short was covered last week, certainly with regards to the much publicized leveraged fund short in 5Y futs, where RBC’s Kristen Arey points out that $4.2mm dv01 was covered last week.
With the rally in USTs this morning (2.47 to 2.41), there is clear evidence that HFs are continuing to take the scale of the ‘short’ position down in the futures complex (ED$ of course as well).
Turning back to stocks, more equity generalists noting discomfort with being ‘too exposed’ to “Reflation” (Cyclicals, Value factor) and / or “Trump” thematic trades (e.g. domestic USD-revenue plays like ‘US Small Caps’ or ‘High Tax / Low Tax’ reform arbitrage) after the incredible run in 4Q16. Instead, we have seen a shift into ‘Secular Growers’ YTD, which would theoretically insulate portfolios from Trump policy disappointments and ‘reflation’ positioning-excess.
‘Secular Growers’ of course are largely concentrated in the Tech and Consumer Discretionary sectors, which just so happen to be the S&P 500’s best performing sectors YTD (+3.5% and +3.1% pre-today’s trade, respectively)…as well as obvious ‘growth’ sub-sector darlings Software (+8.0% YTD), Internet (+6.6%) and Biotech (+6.4% YTD).
‘Defensives’ / ‘Low Vol’ not surprisingly also a beneficiary of the year-to-date mean reversions and rotation out of “high beta cyclicals.” In the micro of today, we see “anti-beta market neutral” strategies (long low beta / short high beta) as the best-performing factor mkt neutral strategies I follow, after being the worst-performing factor market neutral strategy of the past 3 months:
EQUITY THEMATIC ROTATION: