MacroVoices #269 Charlie McElligott: The reflation that reversed course in April will reverse course again

Episode Summary

Executive Summary: The episode argues that the macro regime is shifting from the old “everything duration” deflation trade into a reflationary expansion phase, but with near-term equity chop likely as sentiment is stretched and options/volatility dynamics dominate. Eric and Patrick frame current market action as an ongoing melt-up in stocks, while Charlie McElligott expects cyclicals, yields, commodities, and inflation to stay important, though April’s reversal hints at a tactical consolidation before the next leg of reflation.

Main Topics: From deflation to reflation to expansion (Priority: 5/5): Charlie describes the decade-long low-rate, long-duration regime giving way first to a reflation trade after the pandemic shock, and now to a more mature expansion phase where leadership may rotate and easy thematic trades become less clean. Equities melt-up and stretched valuations (Priority: 4/5): Eric argues the S&P 500 remains overvalued but is still in a crack-up boom/melt-up, with little evidence of a near-term crash despite long-term crash risk. Dollar weakness and global monetary expansion (Priority: 3/5): The U.S. dollar’s failed breakout and ongoing consolidation are framed as part of a global race to the bottom in monetary policy rather than a confirmed new downtrend. Oil breakout and potential demand shock (Priority: 5/5): Crude’s breakout above the prior range is tied to strong demand, low inventories excluding the SPR, falling U.S. production, and Goldman’s call for a huge demand surge that could push prices toward or beyond $80. Gold versus yields and real rates (Priority: 4/5): Gold is seen as constructive above key resistance near $1,800, but a sustained move higher in 10-year yields—especially real yields—would threaten the metal. Volatility, gamma, and systematic flow dynamics (Priority: 5/5): Charlie and Patrick spend significant time on vol-control, dealer gamma, and gamma flip levels, explaining how options positioning can suppress volatility in long-gamma regimes or amplify moves once short gamma is triggered. Near-term chop despite bullish macro backdrop (Priority: 5/5): Backtests on sentiment, vol, and quadrant transitions suggest the next 1–3 months may see thematic rotation and sideways-to-down equity action even if the broader reflation trend remains intact.

Key Arguments: The old low-rate, long-duration trade was built on the post-GFC QE regime; the pandemic and massive fiscal/monetary response forced investors into cyclicals, value, commodities, and higher-yield beneficiaries. A shift from recession/recovery into expansion can produce a more nuanced market environment: high-beta cyclicals may stop outperforming while secular growth and defensive low-risk factors can temporarily stabilize. April’s reversal in growth versus cyclicals is consistent with a transition phase and may persist for another 1–3 months as the market digests peak reflation. Sentiment is extremely elevated, which historically has led to weaker forward returns and lower hit rates over the next three months. Volatility remains unusually subdued, but if realized vol or dealer gamma regimes shift, systematic strategies can create outsized market flows and sudden air pockets. Crude oil has breakout potential because demand growth can outpace supply adjustments; the industry cannot react instantly to fast-moving demand changes. Gold is more dependent on real yields than nominal yields alone; if nominal yields rise without a parallel rise in real yields, gold may remain supported. The dollar’s weakness is better viewed as consolidation within a global monetary easing environment than as a confirmed collapse. The S&P 500’s path of least resistance may remain upward in the near term because long-gamma and vol-control buying can dampen selloffs and add fuel on small dips. A Fed communication pivot toward tapering QE is likely coming, but it will probably be gradual and well-telegraphed, not an immediate rate-hike shock.

Data Points: S&P 500 level: 4,200 - Eric notes the index is sitting exactly at 4,200 at recording time. U.S. Dollar Index: under 91 - Patrick says the dollar has been slowly sold off through April. Dollar resistance: 92 - Eric identifies 92 as the key resistance level whose failure invalidated the breakout. Dollar support: 89 and change - Eric says the dollar is still holding above prior support near 89. WTI crude oil: $65+ - Crude breaks above the prior $58–$64 sideways range. Gold price: around $1,800 - Gold is consolidating just below the key breakout area. Gold moving average: 100-day MA near $1,804 - Charlie says 1,800 and the 100-day average are merging as resistance. 10-year Treasury yield: around 1.64% - Eric cites the yield as off recent lows and rolling higher. 10-year yield prior cycle high: about 1.767% - Charlie references the prior high as a level that could alarm markets if exceeded. Gold risk level: above 2% on the 10-year - Charlie says a move beyond 2% would change the picture materially for gold. Oil inventory (headline): 90,000 barrel build / -1.3 million barrels depending on SPR treatment - Eric explains the weekly oil data and the strategic petroleum reserve adjustment. Cushing crude inventories: +722,000 barrels - Weekly oil storage change at Cushing, Oklahoma. Gasoline inventories: +92,000 barrels - Weekly U.S. gasoline stocks increased slightly. Distillate inventories: -3.3 million barrels - Weekly distillate stocks drew down sharply. U.S. oil production: 10.9 million barrels/day - Production ticked down by 100,000 barrels/day. Goldman Sachs oil demand view: +5.2 million barrels in 6 months - Charlie highlights Goldman’s forecast as a potentially historic demand surge. Goldman Sachs crude target: $80 by summer - Referenced as Goldman’s view and Charlie says he thinks it may be right. Nomura U.S. sentiment index: 99.6 percentile - Charlie says sentiment is extremely elevated by historical standards. Sentiment study forward return: +70 bps one month, no excess return - Charlie’s backtest for very high sentiment conditions. High sentiment 3-month median SP return: -2.1% - Charlie says sustained high sentiment tends to lead to weaker forward performance. VVIX percentile: 96th percentile - Charlie notes tails were richly bid relative to low base volatility. VIX 12-month rank: 2.8 percentile - Base volatility is extremely low in Charlie’s vol study. Vol study 3-month average SP return: -2.2% - High VVIX/low VIX conditions were associated with weaker forward returns. Vol study 3-month median SP return: -1.0% - Charlie’s preferred metric for the same vol setup. Vol study hit rate: 38% - In the high VVIX/low VIX condition, the market rose only 38% of the time. Vol-control estimate: $15 billion of buying - If daily SP returns stay within about +/-1% for the week, Charlie estimates vol-control buying. Higher-vol-control estimate: $21 billion of buying - If daily moves are only about +/-50 bps, estimated buying rises further. Dealer gamma: about $13.5 billion - Patrick says the market is near a substantial long-gamma position. Largest gamma strikes: 4,150 and 4,200 SPX strikes - Charlie says spot is pinned between these major gamma levels. Gamma/dollar delta rank: 67th percentile gamma; 89th percentile delta - Patrick describes positioning as substantial but not extreme. SPX realized volatility: 8.8% (10-day), 9.7% (30-day) - Patrick highlights how low realized vol is compared with implied vol. SPX implied volatility: around 14.2 - Patrick says implied vol remains above realized vol but is low by historical norms. 1-year Russell 2000 performance: +16.4% YTD; nearly +80% over 1 year - Charlie cites small-cap cyclicals as major reflation beneficiaries. Leverage factor 1-year return: +80% - From Charlie’s thematic/factor performance table. Value factor YTD return: +29% - Charlie says value versus duration sensitives has been a major winner. 10-year yield-sensitive factor: +96% over 1 year; -3.5% month-to-date - Charlie uses this to show reflation winners have recently paused. Spin-offs theme: +111% over 1 year - Charlie’s thematic basket illustrating speculative market behavior. Recent IPOs theme: +109% over 1 year - Part of the speculative theme performance table. Liquidity beneficiaries theme: +99% over 1 year - Charlie highlights strong performance in liquidity-sensitive themes.

Pivotal Quotes: "I think these valuations are crazy overvalued, but everything I see is a crack-up boom in progress, suggesting they're going to get even more overvalued." — Eric Townsend: Eric’s view on the S&P 500 during the opening market wrap. "The reflation trade that kind of reversed and started to go away in April is likely to reverse again and come back with a vengeance with still more reflation to come." — Eric Townsend: Opening framing of Charlie McElligott’s macro outlook. "April was a glimpse of kind of the opposite world, where you really had a situation that ran contra to kind of everybody's positioning." — Charlie McElligott: Charlie explaining the recent reversal in factor leadership and why near-term chop is likely.

Implications: Listeners should expect continued macro rotation, not a clean one-way trend: reflation likely remains alive, but sentiment, vol, and options positioning point to choppy equities and abrupt factor reversals. Oil and yields may keep rising; gold depends on real rates; the Fed’s taper messaging becomes the next major catalyst.