Confused by the suddenly “loud noises” emerging from what until very recently was a quiet, peaceful equity market? Then here is one of the best possible explanations of what is happening today, courtesy of RBC’s cross-asset guru, Charlie McElligott.
LIVE DE-RISKING: The de-risking is real so far today into this US election scenario re-pricing / hedging scramble (VIX +17.0% & VVIX +9.8%, while intraday CBOE equity put / call ratio is at 2nd highest level of the year at 1.52)…and with it, a re-pricing of Dec Fed hike probabilities as well. The global equities “US as a hiding-spot” is now being exposed, with HF-heavy small cap significantly underperforming large cap (again, nearly 2% underperf in Russell vs S&P over past six sessions as a de-leveraging “tell”); HY CDX is at four-month wides; Yen, Swiss Franc and Gold are all at highs of the day and contributing to the USD being hammered with DXY -0.8% (again, as I believe the market re-prices now a lower probability of December hike).
‘TRUMP HEDGE’ SCRAMBLE IS REAL—USDMXN 1M VOL:
USTs FINALLY CATCHING A BID: At first blush I was surprised that there hadn’t been more of a ‘bid’ to USTs on this significant “risk-off” trade initially, until I contextualized it again from the perspective of the YTD supply / demand drivers. “THE” overseas real $ buyers were not there today in the MBS market earlier (where said demand-drivers have been focusing their buying instead of USTs over recent weeks), as there has effectively been a “buyers strike” from this group of investors who’ve previously been there to buy any and all meaningful dips in both markets until seemingly AFTER the US election shakes out (FWIW, we have seen blasts of faster money covering shorts with solid resistance at the 1.875 level which in theory could take us back to levels (1.80) in which we would recommend laying shorts back out). Now we are finally seeing a FTQ bid as Spooz break 2100, indications that it’s quant CTA flow in nature behind the buying.
CREDIT ETFs MESSY: Another talking point is the ongoing beat-down being seen in the credit ETFs, especially in regards to redemptions / outflows currently being experienced. Last week, HYG (high yield corp bond ETF) saw $1.8B of outflows, while LQD (investment grade bond ETF) saw $1.7B in redemptions. Today Chris Johnson on our ETF team pointed out that there was another $503mm outflow from the high yield sector yesterday, while LQD experienced an additional $387mm of redemptions as well. On the flipside though, BKLN (bank loan ETF) has seen +$222mm of inflows over the past week though, making +$2.4B over the past six months. What is this telling us? Clearly, this is further evidence of the “inflation impulse” theme is catching-on to fixed income investors (see here on WSJ covering TIPS inflows of late http://on.wsj.com/2fdQEBz). But too, it’s also showing us that the yield hunt trade is still very much intact…BUT investors looking to do it with less interest rate sensitivity. Bank loans are a great option under this scenario as they are a floating-rate instrument, thus acting as a high yield vehicle + inflation hedge. Interestingly though, the rotation into bank loans from HY is also indicative to us that investors are only focusing on duration risk, and STILL not on credit risk at this time.
NOW ADDING SHORTS AND CUTTING LONGS IN STOCKS: As referenced over the past week + in the “RBC Big Picture,” we’d been seeing clear evidence of “grossing down” behavior from HFs within US equities space earlier last week…but now too we see a pivot, with shorts actually being PRESSED over the past few sessions while longs are being taken-down (High HF Concentration basket -2.2% on day, -3.0% over past five sessions). This would fit with fresh JPM PB data indicating that net exposure is now just in the 25th percentile historically after longs were slashed meaningfully over the past week.
SHORTS NOW BEING PRESSED INSTEAD OF COVERED OVER THE PAST WEEK:
MECHANICAL ‘VOL CONTROL’ DELEVERAGING IS CERTAINLY PART OF THE SELLING: Hilariously, SPX 5 day realized vol is 7.3 (as I type it’s rapidly re-rating), and actually bottom-ticked at 1.38 last Friday (!!!), which shows the extent by which the market had priced the election as “in the bag” to HRC, and just how quickly things changed following the FBI investigation stunner. Funds clearly caught under-hedged into this latest iteration of the “October Surprise.”
The thing is, even for shorter-term “vol control” models, we’re still a good distance away from the benchmark ‘10’ level where popular / default ‘moderate’ de / re-leveraging triggerS are set, with again 5 day realized at 7.3, 10 day realized at 6.6 and 15 day at 6.6 as well. That said, at this frantic vol buying pace, with VIX +17% on the day, it won’t take much longer until further mechanical deleveraging is triggered from these extremely popular retail and ALM vehicles (and FWIW, there are oodles of tgt vol funds where the ‘conservative’ setting is a ‘5’ realized vol, so some rebalancing into the fund’s cash leg OR low beta equities has already been triggered).
Similarly, many in the past two year’s investor inflow favorite “uncorrelated” managed futures / CTA trend community use both said ‘vol controls’ as well as technical levels as indicators or risk-overlaps. As has been relayed to me, the fact that S&P eminis today made both a new 40 session low AND broke their 175 day moving average is a significant ‘reversal’ signal for the systematic trend-following universe.
Long story short, be prepared for another deleveraging wave (which could be happening ‘real time’ as I send) the longer vols stay at these levels, bc they’ve just been ‘stuck’ so low in recent weeks.
SHORT CONVEXITY MODELS ‘CAUGHT-OUT’ AGAIN OFF THE VOL ‘BASE EFFECT’: VVIX to VIX ratio (vol of vol to vol..got it?!) as an ‘inflection indicator.’ 
SPX ACTUALIZED VOLS “BASE” EFFECT:
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