During the first week of July, Asset Managers gained long exposure to equity derivatives and the long end of the US yield curve while selling the short end, a Bank of America Merrill Lynch derivatives positioning report notes. Certain managed money likes the more industrial metal silver and is fading gold against relative strength concerns, the report concluded, citing CFTC trading data. Looking at a momentum radar, analysts note that in two key CTA markets their indicators are pointing to a potential trend change.

BAML 7 19 rotation map

In the face of a rising stock market, CTA returns can tend to soften as BAML notes a waning “safe haven” trade

In what could be a chink in forthcoming managed futures CTA returns, the July 15 report titled “Technicals Explained: Use RRG as your relative rotation radar” noted weakening in key markets that include gold and the Japanese yen. BAML analysis shows that “perceived safe havens” continued to weaken, but the report did not tie the safe haven weakening into the Brexit vote ending in a general whimper, the most recent major fundamental impact point.

The flagging trend in safe haven assets might be logically correlated with the seemingly illogical summer move higher in stocks. Explaining stock market strength in the face of almost historic headwinds is challenging. In the EU, where insiders have been watching Deutsche Bank derivatives exposure with keen interest, a European bank bailout is currently in question from an EU court. The EU has strong rules about bank bailouts — bond investors and depositors must take a haircut with a bailout — but the banks, judging from recent public statements, don’t believe this is feasible.

But that is not all. News of horrific torture coming out of the France terrorist attack and a low-tech truck massacre in Nice frame advancing terrorism concerns. Combine this with racial unrest in the US and an apparent faltering of democracy — once again — among a key Islamic “friend,” Turkey. In a world where Turkey dismisses 15,000 school teachers in a coup aftermath one might logically conclude the world appears to be a mess.

Such pedestrian concerns are not the stock market’s problem, which has gone on a ten-day buying binge. Not even tightening poll numbers showing Teflon Donald Trump gaining presidential ground appears to be impacting a stock market driven by an apparent sense of summer delusion. For traditional “Leveraged Funds” performance, as modeled by CTA strategies, this might be a difficult market environment if BAML analysis is correct.

BAML 7 19 asset mgr versus leveraged funds 2 stocks Momentum Shift Gold USD

BAML: Asset managers rotate up the yield curve, while leveraged fund sell short end of curve

Looking at documented asset flows, BAML’s Jue Xiong and Stephen Suttmeier show the often discretionary Asset Manager category has been cycling from the benchmark 10-year Treasury, taking out -$20.4 billion in assets, and shifting towards equity exposure. The $22.5 billion that moved into U.S. equities is almost equal to that which left the heart of the US Treasury curve. However, there is no document-able public data showing direct causation between the directional location of the -$20.4 billion that moved out of Ten Year Note derivatives.

Leveraged Funds, those with significant derivatives knowledge, sold the short end of the yield curve but moved out the yield ladder slightly. While -$10 billion worth of exposure left the 2-year Treasury another $10.6 billion found its way into the Ten Year note.

These Leveraged Funds dis-guarded -$4.6 billion of EURUSD currency spread trades and bought $1.6 billion of AUDUSD in a technically unrelated move. The AUDUSD spread is often considered more of a commodity play while the EURUSD spread was considered a Brexit play to a degree. Leveraged Funds sold $1.8 billion of the small cap Russell 2000 vs. adding $5.5 billion of S&P 500 exposure. This is the one area where the typically more Wall Street orientated “Asset Manager” and the more derivatives focused “Leveraged Funds” category found common ground. In derivatives both added net long exposure to the S&P 500 and AUDUSD.

Separate algorithmic analysis indicates flagging momentum in gold, but traditional momentum models have not yet been triggered and a technical market environment change has not occurred. Likewise, the JPYUSD currency pair has faltered but mid-term algorithmic trend change models have yet to be triggered. If anything there is a potential mean reversion pattern forming, but it is much too early to determine. Mean reversion could be several trading sessions off if it comes at all.

BAML 7 19 asset mgr versus leveraged funds Momentum Shift

Follow the rotation momentum patterns with Xiong and Suttmeier by considering August / September CTA performance

Xiong and technical analyst Suttmeier follow Relative Rotation Graphs (RRG) that has stocks, measured by SPX, dead in the middle of the road.  The cyclical detection method, developed by Julius de Kempenaer, considers relative strength of markets relative to benchmark averages. This is also a method that some relative value CTA strategies use to determine trend extension and to a degree mean reversion.

It is with this analytical hat on, Xiong and Suttmeier not only determine a flagging yen and gold market, but they note a rotational shift on their radar in Emerging Markets. The MSCI Emerging Market index “improved both in relative trend and relative momentum last week, they remained in the lagging zone over a 13-week time frame, along with MSCI EAFE, EURUSD and shorter duration U.S. Treasuries.”

Will their momentum analysis, which at times deviates from algorithmic analysis, prove accurate? The benchmark for Xiong’s and Suttmeier’s undoubtedly interesting momentum work might be found in managed futures CTA August and September performance numbers. If they are correct, and key managed futures CTA momentum markets such as gold and the yen falter, managed futures CTA strategies might experience a performance pause. The issue will not be decided until traditional CTA strategy models receive a full blown signal. There is potential for key CTA markets to be taking a cyclical breather, which is not uncommon.

The trade signals generated after the Brexit vote, such as in the British pound, have faltered and could be in the early stages of mean reversion. These are not good markets for CTA momentum strategies, but certain volatility strategies might benefit. Combine faulty post-Brexit trade signals with the potential for trend change in key markets, and CTA performance could pause over the near term. That said, mid-term between now and the inauguration of a new US president the general strategy looks promising so long as fundamental market triggers result in sustained price persistence.