Markets continue their advance, shrugging off the brief weakness on the back of Moody's downgrade of the US last Friday, with major European and US indices now trading only 3-4% below their February all-time highs, marking the fourth positive week since the bottom on 7 April.
Although the concensus view appears to be that the market has advanced too fast too soon and that we are overdue a pull back, further supported by the old adage of “Sell in May and go away”, we remain more constructive on the market direction in the remainder of the year as the core elements of our optimism still remain intact, namely the progress in tariff deals, continued strength in US earnings, both in absolute and relative terms, resilient macro data and further confirmation that the Trump administration does, after all, care about the stock market. However, we do acknowledge that upside in the short term may be capped, absent any new incrementally positive news, although we still believe news on tax cuts and more targeted fiscal spending would likely drive renewed interest in the US.
Turning to our usual dive into positioning, the recent surge reflects repositioning by CTAs and Hedge funds which posted the second-largest notional buying in five years, mainly via short covering. Gross leverage now back at all-time highs with net exposure relatively low, suggests that Hedge funds still maintain a short bias. We have also now started seeing Institutional investors adding back to US equities, reflecting broader risk-on sentiment across the board. Declining volatility supports additional reengagement by volatility control funds in tandem with the US Corporate buyback windows now being fully open. Global M2 liquidity, which has closely tracked the performance of crypto markets, also points to further upside in the medium term. However, as previously mentioned, significant positive dealer gamma around 595-600 for the SPY and significant negative gamma around 580-585 will likely keep prices range bound in the short term. Supportive of a further decline in volatility is top-of-book liquidity for the ES1 increasing almost tenfold to USD9-10mn (Average USD13-14mn) from the USD1-2mn lows on 7 April.
Key events for the week are the US Initial jobless claims (consensus 228k, last 229k) and US Continuing jobless claims (consensus 1883k, prev. 1881k) on Thursday, UK CPI on Wednesday (consensus Core CPI 3.3% YoY, prev. 3.4%) and Japan CPI on Friday (consensus Core CPI 3.2% YoY remains unchanged).
Although we acknowledge the risk-reward from the current overextended price levels is asymmetric to the downside, due to the fact that we 1) see a low probability of a deep pullback, and 2) believe it is hard to time or measure the magnitude of a shorter pullback, we choose to play the upside given our constructive view on equities for the remainder of the year. With the QQQ reclaiming its bullish channel, we propose Long QQQ Jan26 565 calls costing 4% of underlying (Spot ref 520, Fut ref 534).