Silver as an investment

RBC Warns “It’s The Melt-Up That Hurts”

After an outstanding start to the year for Equity hedge funds, this most recent gap move higher in stocks (while rates and FX remain firmly ‘in range’) is pretty-much exactly what RBC's Charlie McElligott warned is a "bad scenario" for equities funds.

Risk-assets to fresh highs alongside a “reflation impulse” re-rack (S&P eminis through their 1 year trendline resistance as we speak, while the early scan (revisions / updates coming later of course) of new positioning data shows a remarkable jump in TY (UST 10Y fut) open interest +70k (!) as shorts re-engage SIZE, h/t RBC Futures). 


  • First-and-foremost, the Trump drive-by statement on a “phenomenal” tax plan to purportedly be released in the next “two or three weeks” satiates the market’s primary desire for clarity and positive-messaging on the tax cuts and how they are going to be funded to keep them ‘rev neutral’ (BAT?  VAT?  Cash flow taxation?  No interest deduction?  A replacement of “amortization of cap goods” by instead a deduction of “capital purchases”?  Have House and Senate somehow shockingly ‘aligned’ after being so ‘apart’ on this topic?)  As a reminder, the tax cuts are by far-and-wide the largest driver of the S&P target upgrades that daisy-chained Street-wide in December.
  • More market rewarding “Good (focused) Trump,” as the President has agreed to honor the “One China” policy in a phone call to with China’s Xi, and squelching fears of “that” left-tail.  And in general, a President Trump that is refocused on “momentum” after the messy immigration battle: TRADE (Xi patch-up and Abe today / tomorrow), DEREGULATION / INFRASTRUCTURE (comments with airlines execs yday) and obvi TAXES.
  • Chinese trade data showing better-than-expected imports and exports (although almost certainly distorted due to the long Lunar New Year).
  • Release of IEA data showing very strong OPEC output-cut compliance (92% of targets, led by Saudi at 116% of cut rate), with now more Ministers calling for an extension (“if it feels good, do it”).  As I say almost-daily now, the QI Factor PCA Model shows inflation expectations (crude primary driver), credit spreads (crude first deriv driver), energy prices (duh…) and risk-aversion (negative correlation btwn crude and VIX at nearly 3-year highs) as the largest macro factor price drivers of the S&P.  This is why I continue highlighting crude as the most-likely culprit behind both left- and right- ‘tail events’ for global equities right now.  In the meantime, WTI is +1.8% and thus breakevens stop their slump to reverse higher for the first time in days.
  • Abe / Trump speculation of further coordination on growth-measures (currency manipulation NOT going to be a topic, but US infra investments WILL #HomnaAccord conspiracy theorists unite) keeping everybody’s favorite old-school risk-proxy $/Y well-bid back through 113.5.

RE-REFLATING: Just as it was on life-support (HIGH HIGH HIGH expectations for this “tax announcement”-caveat emptor), “reflation” takes one more swing. 


EQUITIES THEMATIC MONITOR EXPRESSING THE ‘FINAL PUSH’ OF ‘REFLATION’ (nicely tracking the view that Mark Orsley and I have been pushing while marketing regarding the ‘final’ equities melt-up over next quarter or two before back half of year interest rate volatility implications sees stocks end off their best levels)-

THE MELT-UP THAT HURTS?: After an outstanding start to the year for Equity HF’s, this gap move higher in stocks (while rates and FX remain firmly ‘in range’) is pretty-much exactly what I was referencing in Tuesday’s note as the “bad scenario” for equities funds:

One challenge going-forward though is the potential of a market breakout higher, where anecdotally I still don’t see a ton of risk-appetite per recent meetings / marketing and PB data on nets / gross. 


“Rich valuations” with “Trump uncertainty” / “implementation delays of pro-growth policy” language is the baseline response from clients in US (and the dreaded ‘geopolitical / election risks’ in EU), which speaks to a ‘pain trade’ melt-up scenario being highly-likely as positioning data still shows that many are begrudgingly along for ride with only one foot in the water.

This also touches on the point I made in the same note about buyside ‘long vol’ trades “bleeding” them of performance as we now see SPX realized vols from 15d, 30d and 90d all below the 8 level, which is a real kick in the pants.  And yes, this comes with short books being squeezed over the past three days the most since the start of December / peak post-election “reflation euphoria.”

VOL BLEED = MAJOR SYSTEMATIC LENGTH IN EQUITIES AND CRUDE: Just a note that we have to assume very significant length in the market from vol-based allocation models (risk-parity, CTA, target vol) in both crude (3m implied vol at 1.5 yr lows) and stocks (SPX 3m 100% moneyness just off January’s 2.5 year lows).  This would of course speak to the potential for “positioning imbalances” that would be ripe for mechanical (unemotional) deleveraging on a sustained move higher…but for now, selling short front-month vol continues to be a profitable-trade.

USD AGAIN IN-FOCUS: As pointed-out in Tuesday’s “Big Picture,” the USD is again ‘getting its legs’ (DXY about to test 111 for first time since January) as the poster-child proxy for the ‘reflation trade’–which until yesterday morning was at death’s doorstep.  Even before President Trump’s utterings on ‘tax policy progress’ yesterday, the Dollar had been showing signs of life for the better part of a week and a half—and is actually now set to see its first weekly gain of the year.  It is pretty clear that the move higher in the Dollar—although with plenty of qualitative drivers (positioning excess washout, Fed speakers attempting to keep March / 3 hike in ’17 “alive,” dovish Draghi / ECB and the aforementioned renewed confidence in a “Dollar bullish” US tax package pending) has been driven by two inputs:  1) the turn higher again this week in US “real yields” (as breakevens finally cracked-lower while nominal yields did more of their chopping) and 2) wider US / EU rates differentials (+11bps since last Thursday).

TAXES—OBVIOUSLY WHAT THE MARKET IS FOCUSED UPON: When on Tuesday I was showing the extent of the “reflation unwind” (rates, thematic equities and FX reversing the mega-trend), I made this specific caveat on what it would take for the USD to regain its status as ‘chief indicator’ of reflation: “This could again change where ‘higher Dollar / domestic reflation’ again “synch” if we were to receive ‘Trump policy clarity’ (taxes) or more robust ‘hard’ economic data that would in turn keep the ‘growth over financial tightening / inflation’ hope alive.”  Some “phenomenal” tax-plan (purported) progress later, and there you go.
This “sudden progress” on tax policy is obviously confounding (but exciting!) the market, as over the past 2 weeks we’ve seen the opposite–a firming of the Senate opponents vocally against the House- and Paul Ryan- supported B.A.T. (as the primary means of funding the tax cuts in addition to the deduction).  Thus, I do think there is scope for IN THIS NEAR-TERM 2-3 WEEK WINDOW for some disappointment with whatever is announced—perhaps a re-branding of this as a VAT, as a “fee,” as a “made in America” mechanism…or some other case of semantics.  As Mark Orsley has stated, dropping the “PAYGO” requirements as a workaround is very low odds…but it in theory would be possible to make this work.  But if it is TOO watered-down with sector / business-specific exemptions, it likely won’t pass WTO muster, NOR will it raise the required revenue to offset the tax cuts….ERGO it’s possible we’d see a dreaded “smaller than advertised” tax cut.  GASP.
That said, there is also a reason I went on the record in Monday’ “RBC Big Picture” that the market is vastly underpricing B.A.T. going-through as part of the House’s tax policy plan, and estimated its inclusion as a 70 delta (instead of say GS’ “20 delta” note last week): Republicans are feeling the heat of their constituency with regards to the two big changes they were promised by the Trump Administration out of the gates: an ACA replacement / amendment and Taxes…and as such, they need to ‘come to terms’ with a resolution ahead of the Summer, as reconciliation is typically a 4 to 5 month process (making these potentially end of ’17 / start of ’18 stories).  Simply put, that timeline is not gonna cut it…so you have to take action and sweeten the deal to get the Republicans on the same page—thus you find the additional ‘add-ons’ and close other loopholes to get the hold-outs something that eases their concerns.