It’s always a good idea to keep an eye on the robots:
We are all bond traders now. Well, bond traders have always been bond traders, but even 18-year-old teenage equity and crypto “portfolio managers” now have to follow bond prices and yields more than any other market indicator for a sense of what happens next.
Why? Because as Goldman noted last week, the move higher in yields was so fast and so furious, that it virtually guarantees more pain in stocks. Recall that in his latest Weekly Kickstart, Goldman’s chief equity strategist (who does not actually trade) pointed to the rapid move higher in yields catalyzed by the latest FOMC statement, and which surged as high as 1.80% before settling around 1.73% today after ending 2021 at 1.52%, a 24 bps rise over just 5 days. This is material because as Goldman has repeatedly shown in the past, the speed of rate moves matters – even more than the actual move – for equity returns. To wit, “equities typically struggle when the 5-day or 1-month change in nominal or real rates is greater than 2 standard deviations. The magnitude of the recent yield backup qualifies as a 2+ standard deviation event in both cases.”
Of course, while bond moves are critical so are the fundamental reasons (and expectations) behind bond moves, such as last week’s payrolls report or today’s CPI. Yes, today’s CPI came in red hot, but because it met expectations and wasn’t even hotter than consensus, yields actually slumped allowing stocks to jump at least in early trading.
But while fundamentals are easily explained (especially when there is a narrative ready to go), traders are far more mystified and puzzled by non-fundamentally driven Treasury moves, such as those the result of often inexplicable buying and selling programs launched by CTAs and other vol-controlled trend-followers.
Which is why as Goldman’s desk trader Scott Rubner writes in a note for very limited distribution to a handful of his preferred clients (available to professional subs in the usual place), “I had >25 fundamental L/S equity fund managers asked me for this yesterday.”
And by “this” he means what CTAs will do to bonds in the coming week and month, or as he puts it now every fundamental long short stock picker has a side job of monitoring CTA fixed income flows.” The good news, according to Goldman’s derivative traders, is that “this dynamic improves dramatically after this week is complete.”
Here are the details, starting with the bad news:
According to GS systematic strats team, global bonds remain heavy for sale. Our team models $133bn for sale over the next week. We estimate that CTAs sold $127bn last week and are now short $125bn.
And now the good news:
The majority of the selling from this cohort is expected to be done by the end of this week. Over the last month, we model that CTAs sold $208B worth of bonds. After this week the flow picture improves and there becomes equal upside risk and downside risk according to market moves.
Ironically, so important is the direction of bond prices/yields that it has taken precedence over the actual technicals of stocks themselves. That said, here is how Goldman sees simulated CTA positioning in global equities over the next week and month.
According to GS systematic strats team, CTAs are not triggered in either direction up or down over the next week in a flat tape. We model that CTAs are Seller of ~$22bn in a month in a flat tape. We model that CTAs bought $23bn of equities in the last week. We model the trigger flip levels substantially lower from here. The level in focus in ES1 is 4466, which is the medium term trigger which is the main level to watch. ie non-economic sellers are lower from here.
In other words, after a few more days of technical bond selling, the flow reverses and CTAs start buying bonds, a move that will only accelerate if yields drop from here for other reasons. As for stocks, they will follow the marching orders of the CTAs, and will not dump stocks unless spoos drop below 4,466, which is a long away down from here.