On Tuesday, we took a look at what works as a hedge during equity drawdowns. Last week, we took stock (no pun intended) of which companies and sectors were most exposed to Brexit and also to a rising dollar.
No sooner had we finished analyzing where to turn in turbulent times than risk went crazy. Stocks shot through the roof. Everything was fixed.
To be sure, the bond market is saying something entirely different as yields on US Treasurys, German bunds, and Japanese government bonds remain suppressed and may well continue to grind inexorably lower from here.
There’s lots of chatter today about quarter-end flows contributing to what’s turned into a blockbuster two-day move. What’s interesting about that is it didn’t appear, going into the week, that there was a whole lot of room for this. Why? Here’s Barclays to explain:
“Rebalance bid for equities at the end of month/quarter is unlikely to be material. Our implied US equity vs. bond allocation proxy is still well above recent lows as US equities are down just 3% in Q2. Additionally, the relative spike in equity vol vs. bond vol does not point to net equity buying by multi-asset funds. The rebalance bid may be more pronounced outside the US where the selloff was more acute.”
(Chart: Barclays)
What’s particularly interesting here is that it certainly looks like active managers aren’t prepared for further outflows. Have a look:
(Charts: Barclays)
The disconnect in the right pane is actually pretty astounding. What Barclays is suggesting, in plain English, is that if the redemptions remain elevated, managers are going to have to sell to meet them. Here’s how the bank puts it:
“The current disconnect between still elevated MF beta and continuing redemptions leaves the market vulnerable as cash levels will likely need to be increased.”
Simple enough. Of course that begs the question: have they become even more over-extended over the past two days?
The other disturbing thing you may want to keep an eye on as we try to hold onto recent gains, is the spread between the onshore and offshore yuan (the Chinese currency). We’ve discussed this here before. The short version goes like this: the offshore yuan (CNH) is more freely traded than its onshore counterpart (CNY) which means the difference between the two rates is a decent proxy for the extent to which the market thinks the yuan will depreciate further. Generally speaking, when expectations for further depreciation grow, risk sells off. In fact, the correlation between CNH volatility and the S&P is almost perfectly negative YTD, meaning when the offshore yuan gets jittery, US stocks fall.
Tuesday evening, China was forced to intervene in the market to keep the offshore yuan from falling any further. Here’s Bloomberg:
“Chinese currency traded in Hong Kong rises 0.18% to 6.6728/USD as of 10:53am local time. Currency surged more than 0.2% in an hour.”
“There was some sort of intervention by selling USD/CNH this morning, hinting that Chinese authorities might push the yuan higher, Commerzbank economist Zhou Hao wrote in a note.”
And here’s what a ‘yuan’-tervention looks like:
So the shaded area there is the onshore/offshore basis (i.e. the spread between the two rates). Note what S&P futures did when China moved in to close the gap Tuesday night at around 10:00 ET.
Clearly we were going to trade higher today regardless in the US on the back of higher oil, a soaring FTSE, and a yen that’s kind of cooperating (for now), but make no mistake, what happens in China no longer stays in China and since last August, the yuan has become a key risk-on/risk-off trigger.
You can expect currency risk to crop up elsewhere as well. "We’re prepared for much more volatility, especially in currencies," Ari Rubenstein, chief executive officer of automated trading firm Global Trading Systems told Bloomberg this week. "This isn’t going to be a one-and-done day of volatility." Here’s some perspective on that point:
Now that we’ve given you plenty to worry about, enjoy the rest of the day and think happy thoughts because after all, it's "rally time."
