The most crowded trade on Wall Street -- long inflation -- is suddenly getting crushed like never before in the post-lockdown era, sparking a spate of forced deleveraging among a broad cohort of institutional funds.
Betting against technology stocks and Treasuries or going long the dollar are some of the most profitable strategies in a year when inflation at decade highs drove asset returns. Now, with producer prices adding to signs of easing price growth, all these bets look shaky.
The tech industry, home to many of this year’s biggest losers, led Tuesday’s rally with the Nasdaq 100 jumping as much as 2.8% before paring gains on geopolitical tensions. Treasury yields fell again while the dollar slipped toward a three-month low.
The market gyrations are dealing a harsh blow to money managers who piled into big wagers that the Federal Reserve’s inflation-fighting campaign will continue to juice yields while boosting the allure of the US currency. It’s also hurting Bank of America Corp. clients who have recently slashed exposure to tech equities to a 16-year low.
The whiplash, spurred first by last week’s cooler-than-expected consumer prices, is particularly painful for trend-following funds such as Commodity Trading Advisors. The group -- which has ridden the inflation trade to double-digit gains this year -- is now mired in the worst bout of performance since March 2020, according to an index by Societe Generale SA.
Whether inflation has peaked or not is debatable -- and investors as well as policy makers have been wrong on pretty much all price trends in recent years time and time again. What’s less questionable is that a crowded trade threatens to unwind all at once, with short covering among fast-money funds adding to market instability.
“The inflation trade, once contrarian, had become consensus,” said Andrew Beer, a portfolio manager at Dynamic Beta Investments LLC. “With CTAs, the problem isn’t trade reversals; it’s crowded trade reversals.”
One effect of all the upheaval in positioning may be that the market is rendering an artificially rosy verdict on inflation. The 6% runup in the S&P 500 since Thursday’s consumer-price report has launched note after note by Wall Street strategists wondering what investors are so excited about -- the CPI showed cooling, though nothing like a material diminution of price pressure. Framed as a byproduct of traders being forced out of ultra-bearish positions, the market’s message is less emphatic when it comes to the economy.
Turnarounds like this have happened multiple times in the past year, with all of them proving fleeting. What stands out this time around is the velocity of movements across assets. Take a Dow Jones market-neutral momentum index that buys the best-performing stocks against the worst performers. It dropped 1.5% Tuesday, extending a loss over four days to 9% -- the most in two years.
The momentum crash was also on display in other markets. The dollar’s 2% tumble on Thursday was the largest since 2015. The same day, two-year Treasury yields fell 25 basis points, the most since 2008.
The volatility has forced some unloading of portfolio assets in a move that represents a “VaR event” in some corners, according to Nomura Securities International’s cross-asset strategist Charlie McElligott, referring to an instance where selling is imposed by the value-at-risk model.
During what he called “momentum shocks” across assets, many traders were forced to cut losses and trim exposure after the soft US inflation reading prompted a rethink of global monetary tightening.
It’s “further accelerating now post this PPI print which only builds ‘dovish relief’ and Fed ‘terminal’ repricing further,” McElligott wrote in a note Tuesday, referring to bets on where the central bank’s benchmark interest rate will peak during this cycle.
At least strategies that rely on overweight positions in fixed income like risk parity are finally getting some relief. The RPAR Risk Parity ETF (ticker RPAR) has climbed almost 6% over four days for its best performance since the pandemic crash. Year-to-date, it’s still down 26%.
What happens next to the great inflation trade is unclear. But Jared Woodard, a strategist at Bank of America, says pricing pressures are likely to persist for years, making any big shift to assets like tech stocks ultimately unsustainable.
“If we are right that we’re under, you know, the very early stages of a big macroeconomic shift, then the valuation reset could be substantial and could be prolonged,” Woodard told Bloomberg TV.
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