Lots More With Charlie McElligott on This Week's SaaSpocalypse

0:00UKG, their HR, pay, and workforce management tools help business leaders empower their people. because when work works, everything works. Learn more at ukg.com slash work. Bloomberg Audio Studios. Podcasts, radio, news. I think there's a chance you might have to re-record an intro or at least the intro might be out of date by the time the episode comes out. That's how you know. That's how you know it's bad. That and when people start waving around standard deviations. Standard deviations. Also, when people start saying it's a healthy correction in the market, although I haven't seen that much of that.

0:39It's pretty gnarly. Also, when we don't just say the date that we're recording, but we say the minute we're recording this at 7.04 a.m. on February 6th, 2026. All the signs are up back. Joe, I want a T-shirt that says Ruthless Utility Maximizer. Black gold. Let's talk about losers. Who cares? I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Skulls Unlimited. Ooh, what's the ticker for that? No, I think that, like, in a couple of years, the AI will do a really good job of making the Odd Lots podcast. How do I get more popular and successful?

1:18One day, that person will have the mandate of heaven. We do have the perfect guest. Welcome to Lots More, where we catch up with friends about what's going on right now. Because even when Odd Lots is over, there's always lots more. And we really do have a perfect guest.

1:41But it is weird, isn't it? Because it's, you know, it's a little different. It's been a lot. Very strange. It's a surreal type of market environment, especially over the last week. Right. So if you've been living under a rock, markets have been tanking. There have been a bunch of different things going on. But first of all, gold and silver and the metals complex started plunging. Then you had like basically a slaughter in software stocks. What else? There was one. Oh. And crypto. Crypto. Yeah. Crypto is a big one. So Bitcoin is like down to 66 ,000, something like that. I think it hit 60 ,000.

2:16Oh, wow. And that's the thing. I can't keep up anymore. No, I know. It doesn't matter. And also there's concern about private credit. because private credit has so much exposure to software. And they basically lent all the money at the top of the valuation cycle, which I wrote about in the newsletter yesterday. But anyway, there's a lot to talk about in markets. Who do we call when markets are moving? That's right. What's up, Charlie? You guys are amazing. So this is Charlie McElligot. Of course, he is the cross-asset macro strategist over at Nomura. I'm going to start with the simple question.

2:50Maybe it's not an easy question, But what was the proximate catalyst for all of this? Because you have a bunch of different things going on, including, by the way, the nomination of Warsh at the Fed. So absolutely part of the feedback loop. But these things are never singular input in a world of thousands of macro factor variables. In this case, and you know I'm an ambulance chaser, that's kind of what my gig is, a grave robber, a carpetbagger, all those things. I try to reverse engineer car accidents. And kind of the qualitative starting point of that is to locate consensus positions that tend to then crowd in positioning.

3:38When trend trades develop, that's usually accompanied or requirement, a requirement being low volatility to accumulate those kind of smooth trends. So point being, I think there were a number of market narratives that got a little lazy. You know, for instance, Q4 of last year, as we recall, I think there was, you know, somewhere three to four months ago, there was still a fair bit of concern with regards to this idea of like labor cracking, you know. And there was still a lot of feedback with regards to Liberation Day and the policy volatility dynamics. Before things really got hot with policy volatility most recently.

4:27And that was leading to some skepticism. And as it relates to kind of the equities world, what did you do? You just stuck in the stuff that kept working. And that was that same dynamic we spoke about a number of times last year. that crowding into secular growth, mega cap tech, AI, they just keep growing earnings, profitability, all of those metrics. And they took up this massive part of the market. That's part of this positioning that said, at some point in Q4, run hot starts happening. You start seeing data upside surprising again, right? He starts openly and more recently transitioning into January, talking openly advocating his weak dollar policy.

5:09Europe is playing along. Trump, right? So you start having these things where people were really accumulating around effectively a lot of short dollar trades. And when I'm sitting there and I'm seeing like how do these narratives go wrong? How does this crowding go wrong? And I'm seeing gold and silver being attributed to this debasement narrative or this de-dollarization narrative. There's credibility in those arguments, but I'm also a skeptic with regards to the flows and the actual singular catalyst of those. But I start seeing those positionings really overshoot. We're not talking like linear projections, like bending off the curve type of price performance of late.

5:48I see EM equities crowding. I see cyclical equities because everybody owns secular growth and nobody had enough economic sensitivity. So I start seeing these kind of positioning overshoots. we know that's all the work that we do internally. And it just said, if the dollar starts agitating and it stops going lower and you start losing these short-term trend windows, and then you get maybe a little bit of, wow, we didn't get the max dovish Hassett trade, right? Oh, we start seeing upside surprise data when everybody's short dollar and thinking rest of world growth. And actually US is maybe leading to the upside again and re-accelerating.

6:25dollar starts performing, people start monetizing and you start taking money out of these trades. And that turns into a bigger de-risking. Obviously, we want to get into like, got to get into everything, including like the software sell off and its connection to silver, et cetera. You know, it occurs to me, speaking of the software thing, and I'm glad you brought up Liberation Day. One of the memes of 2025 was just this idea that, well, look, we don't really know what tariffs are going to do. We're not really sure what effect they're going to have on the economy. But one thing we could be pretty sure of is that it's only going to affect the sort of physical goods economy and not the digital economy.

7:03And so tariffs in a way sort of seem to embolden the software, maybe crypto digital trade, because it's like this stuff is borderless. It doesn't it's not going to get held up in customs. So let's lean into this. And then so it's interesting to hear, you know, then you get this big reversal. Can we measure it when you talk about like how leveraged and how consensus these trades were, whether we're talking about software or whatever, can we measure how crowded those trades were, how levered these trades were? Absolutely. I mean, I'll, I'll look across, you know, we, we, we have internal money that we run within QIS businesses where there's billions of dollars behind, you know, very sophisticated, not like naive toy models from trend to risk parity, you know, vol control, target volatility.

7:49So I look at where those gross exposures are and like period point blank, grosses were too big. Right. If you look at a snapshot of a model risk parity portfolio for assets, long only using leverage to allocate your volatility. Right. Long only and equities, bonds, credit, commodities, different weightings based on different economic scenarios, like very kind of generic risk parity. we're seeing on a, let's say a five-year look back, 99 spot, seven percentile gross exposure. It just so happens, right? Goldman Sachs prime brokerage data with regards to equity hedge fund grosses as of last Friday, 100 percentile on a five-year look back.

8:35So these are synonymous. Now, gross exposure is not purely a function of trailing realized volatility, right? Different strategies deploy different leverage. Different strategies will try to amplify a market neutral versus a net lean or a directional lean. But by and large, the grosses were too damn big. It's like the guy that used to run for mare. And when you see grosses being that big, and you see prices bending off the curve, and you see the thesis behind it, and this is where I'm pumped to tie in like the Bitcoin read, right? Yeah. If debasement was actually what people are saying it was, right?

9:17This idea that in de-dollarization, you know, moving away from fiat, you know, US policy volatility, US fiscal deficit, which by the way, okay, like same with Europe, same with Japan now, you know, with their little trust moment, you know, Europe is taking the austerity break off. That's a global phenomenon with fiat currency. So like, okay, I can get with that to a certain extent. I'd be like, why didn't Bitcoin participate? That's what people kind of claim is, you know, Bitcoin's a shapeshifter, as is gold. But, you know, my story and my skepticism with regards to that debasement or that de-dollarization was the way that Bitcoin absolutely did not participate when it was gold and silver.

9:55And look, I sit in an options business, I see just outrageous call skews and demand for upside and people keep putting on, keep reloading into these call spreads and upside trades and SLV and GLD. The options volumes are massive. It became a speculative macro tourist retail type of a trade on top of all this. But Bitcoin kept going lower. And I started seeing, one, if people are grabbing – people clearly have this preference for real assets, physical assets right now in this world of debasement, of fiat, of fiscal deficit spend, perpetual issuance, all of those things. Bitcoin is trading like software.

10:36It's trading like SaaS, which is going through an existential crisis right now for really justified reasons, especially with regards to valuation. right? And the funny thing is when we were talking about, you know, how AI was actually going to, I was making the point kind of Q4, start of Q4 last year, there's two major tailwinds for equities that become potential headwinds in 2026. They're very well socialized, but they still ring true. Ironically, we kind of got a backdoor on it. One was that the CapEx spending with regard to AI, you know, was burning your cash and you're moving through the cash so fast, right?

11:14And the cash that made these companies so preferred. So, you know, screening is quality and profitability and all these great things. They're liquid. They're big. You can move in and out of them. They only go higher. And they did a bunch of buybacks. Well, that's the trick, right? So like you aggregate kind of like the MAG7 or like, you know, maybe the 12 biggest kind of like AI contingent types of players. You're talking like 20 to 30 % of the overall S &P 500 buyback. So that's a huge point for me because I've made this before, buybacks are like seven to eight X, the largest source of demand for equities over the past 15 years.

11:47And it's a vol suppressor. Yep. Right. I mean, you are a passive bid. You're a passive bid under the market on a view up order, or more importantly, when there is a drawdown, that's when they get most active. So it's like long gamma, it's like synthetic long gamma in the market. So one, you're burning through your cash and you're no longer doing that. Two, you're burning through your cash and you're no longer buying back stock as this vol shock absorber and passive bid into the market from kind of sort of a quarter to a third of the overall S &P's buyback that you're then too having to take on this new debt.

12:18You take on new loans, you know, to a certain extent, you're trying to lever the balance sheet. But, you know, more importantly, what does that mean for credit? Credit has been this perpetual kind of vault bleed because spreads are so tight. Credit just doesn't move. Issuing to fund buybacks as well. Yeah, a hundred percent. I mean, ironically, that's probably a separate podcast, But remember, we used to kick and scream like, oh, QE, this is crazy. Like this malinvestment, like they're bringing debt for buybacks and they're not doing, you know, R &D and they're not spending CapEx. They're not building plans.

12:48Well, here you go. You know, Druck said something like this, you know, many years ago in an interview. He's like, actually, when you start to see, you know, the cash turn into CapEx spend, there's usually kind of a point of agitation. And it's not always in the right direction for equities, let's say. Right. And in this case, I think we're starting. Obviously, you're starting to get that, but the credit point is critical because the pace of the CapEx kind of prisoner dilemma that we're still seeing right now, like yesterday's earnings releases, the magnitude of that supply in the investment grade market is simply going to widen spreads.

13:23Tech is a big part of that. Now, this is the punchline, bringing it back to software, bringing it back to Bitcoin. as we were all kind of watching this potential for you know the credit markets to become a headwind not in a shock not in a freeze you know not anything close to a systemic dynamic just too much supply with spreads too tight you're not being compensated for it so like there was kind of this general shortened credit because guess what the whole world is watching one in like baby footsteps can oracle get their funding done that was the one day we had a sigh of relief this week by the way.

14:00They got$25 billion of investment grade done plus converts with like$129 billion of demand. The market, huge exhale. But guess what? OpenAI is still in the background somewhere. We're like kind of, sort of in the next two months, they got to come up with like anywhere from$100 to$200 billion. And that is still a major point of skepticism. It's not a funny punchline, is it? No, it's not. It doesn't make you feel really good. But here's the thing. As Anthropic has done their thing, and I mean, bang, you guys are in it right now with regards to Claude and the implications of VibeCoding and a whole reset with regards to certain industries and taking out, even if it's just the basic level of legal compliance documentation, and we've seen it start to hit bottom lines with regards to earnings mentions and things like that, that is happening so fast that software is going through this existential crisis.

14:46And here's the deal. Those dudes are stuffed on restricted shares. They're stuffed on RSUs. And the concentric circles of VC boys and tech boys and SaaS bros and Bitcoin bros has a lot of overlap. It's all the Bs, boys and bros. It's not a Venn diagram. It's just a circle. It's kind of like straight up overlap. And in this sense, you can't sell. You're kind of being haircut 10%. It feels like every week right now with regards to do I have a job? What are the prospects? Where is this industry going? And what do you have to sell? And I think that that's why it is trading tick for tick year to date with SaaS software.

15:30And it's quite remarkable. And that to me, as I step back to this large conversation, it's not really about debasement. This is a digital phenomenon. This is a liquidity crunch with regards to the idiosyncratics of that sector really coming under attack. And by the way, now it's also become a backdoor credit story where it's not simply the spread widening from the hyperscalers. It's people worrying now about private credit, private equity, the BDC guys, which are sitting on a lot of this stuff with really tricky valuations and not a lot of like buffer room with growth covenants and things like that.

16:06So it's become a huge macro story. They kind of did the end around with regards to where we thought it was going to come. But we can handle a couple of things at once. You know, all of a sudden you get a little bit of a surprise with regards to the Fed share, dollar stabilizes. You already had people in all these short dollar trades. People start taking money out of, you know, gold upside, silver upside. They start taking off some EM upside. And at that point, like last Thursday, I'm looking at grosses. I'm looking at our CTA trend net exposures in commodities and metals, 98th percentile. I'm looking at our net short dollar exposure, zero percentile.

16:45Look at our net equities exposure, 97th percentile. I'm saying these are the qualitative things I need to see where profit-taking and monetization turns into a risk management exercise.

17:15people. Because when work works, everything works. Learn more at ukg.com slash work. So speaking of selling what you can and not necessarily what you want, one of the reasons that yesterday, February 5th, I guess, was so painful is because we started to see the places, the few places where people were able to hide start to go down. So consumer staples, for instance, It wasn't a big drop, but still they'd been surging earlier in the year as people sort of switched out of software and into consumer goods. But now it's not quite clear where they're going to go. So correlation seems to be picking up, right?

17:57Like in a market crash, correlation goes to one. But at the same time, I can't figure out what's going on with implied correlation, because if I look that up, it's still pretty low. So this is absolutely topical, and it's something that we continue to get questions over the last few years, that generic, like, why is vol so low? And low vol or high vol is incredibly subjective. It's about the vol surface. It's about skew. It's about where the starting point was, where you've moved from, how quickly. It's art plus science. The part of the problem with vol in general certainly being sticky, and I think it comes down to where the money has flowed with regards to the hedge fund space, is that maybe 10, 15 years ago, the long, short universe, running net exposure was, I don't want to say necessarily dollar for dollar, like axed or necessarily larger than the multi-strats at the time.

18:56but like they ran net and they would lever up positions or they would hedge their longs. And they were, you know, generally speaking, there was buyers volatility with those guys to a certain extent. You know, if you look back kind of on the sort of, let's say, five at 10 years of dollar flows into the hedge fund space with regards to all new flows, multi strats are conservatively 80 cents of every dollar in. And then if you actually include outflows from other strategies, you're legitimately through$1. So the point I'm making here, and multi-strats are unbelievable with regards to their low volatility, with regards to the consistency of their returns, with regards to the discipline, risk management, the tight stops model, the non-correlated returns, which is the whole story why people keep allocating into them, they've proven to be such an absolutely undeniable force, hence all this dollar flow.

19:58But think about it like this. We don't see the core ones anymore. And this is like - Core ones? Core ones, meaning like when things shock, everything trades up together or down together, right? And that was kind of the old state of the world. But now what we tend to see, and this is exactly what we saw earlier this week when you had, you know, of course, financial market returns are not on a normal distribution. But for, you know, I hate people that point that out. It's like it's like like something in a pharmaceutical. Yeah. Like you have to include it because otherwise someone annoying. Don't take this drug if you're allergic to this drug.

20:32Yeah. So the point here being that, you know, you would see kind of like a risk on risk off type of core one phenomenon, you know, in past era. Part of what is happening now in my mind with these little bit of fragmented bullet points triangulating here is the fact that the dollars and the leverage controlled by the market neutral multi-strat equity space are so overwhelming in the sense that when you are forced to de-risk or de-gross, the tilts go wrong. that you have the offsetting short on the other end, right? It's not just you stop out of your net longs or your crowded longs, right? It's that you're also, you know, theoretically an equal dollar amount on the short side being covered.

21:26And what ended up happening on like the two big down days this week, it was like 250 stocks were up, 250 stocks were down. So you're getting this like reverse dispersion, right? Very much the opposite of what last year was, which is this crazy concentration of like top decile, bottom decile, just spread 99th percentile, like a 10-year basis, which feeds into why people are loaded into momentum, right? The higher stuff keeps going higher. It's human nature. This is like Fama and French. This is factor alpha, you know, commoditized alpha. So these things, I think, due to this kind of where the dollar flows have been, the market neutrality, the fact that there's always this offset against it, you're not getting core shocks.

22:05And when you don't get core shocks necessarily, at least initially, because vol did not really react until just like two days ago. And yesterday, vol-vol got a little tricky too. But point being, you need correlation as an input to higher vol to sustain. And you're just not getting that. You still have low core. Now, the trick is, to your point, Tracy, it's very interesting. You mentioned the defensives, right? The reversal that we saw when people said, look, I'm too much exposure in secular growth, mega cap tech, AI, which gives you a lot of momentum exposure, a lot of unintended kind of exposures that when people said, I need more economic sensitivity, I'm taking up my cyclicality.

22:45The three best performing sectors kind of year to date for most of the year have been like energy, materials, industrials, stuff that people have kind of been underweighted for the longest time in the absence of a hot economic cycle. But also too, when you started seeing defensives joining that rotation. It was this massive value over growth trade. And that's the three, four, five Z score types of moves that you're talking about where people didn't have that stuff on and your longs go against you and your shorts go against you. And that is also amplifying these kinds of moves because look, it's not just the market neutrals.

23:18They're not boogeyman here. They're unbelievable. They barely lose money ever on a monthly basis. They just have very disciplined, tight stops to get out of these leans and tilts hard and fast, unemotionally. But guess what? It's retail. It's all the story stocks, all these themes. That's why I pointed out for the last two years of the boom in leveraged ETFs, like 82 % of the assets in leveraged ETFs, which act like synthetic negative gamma, right? The higher you go, the more you have to buy at the end of the day, the lower you go, the more you have to sell. you know, massive pool of AUM now because of like retail, you know, tilted speculative leverage behavior are tied into that concentric circle of AI, mega cap tech, semis, you know, disruptor crypto.

23:59So we're super overweighted, super over indexed to that stuff, which amplifies when you have the tight market neutral stopouts, you know, with all that leverage, with all that AUM, you know, to get their factors right. Because at the end of the day, those guys are not trying to make factor bets. There's scenarios where you maybe run even a little net if there's like a big, you know, economic reacceleration trade or something like that. But generally speaking, the idea is like, we don't want beta to the S &P. That's the point. That's why people pay us. Stop comparing us to S &P returns. So all these things are part of this like backdrop plus the narrative overshoots to me.

24:34That was fantastic. And it's very intuitive. I mean, there was already good theoretical ideas for thinking that the multi-strats were huge drivers of all this. And then when you add in the fact that the staples, like the sort of underloved areas or energy materials are the winners, very intuitive to your point. On software, you know, no one really knows, obviously, the degree to which AI is going to obliterate these businesses, obviate these businesses. No one really knows. But like from the perspective, you mentioned the tight stops that each manager has within these firms. Can you give us like some sense of how much is it like, look, I just want to keep my job here and this is the ugly stuff that's going on.

25:17And so I'm just going to sell now and ask questions later. How much does that play into on a week like this? Well, we're talking about wide swaths of strategies and active, systematic versus field directional trading. And tight stops are typically that down 2%, kind of down 1.5%, maybe even in some cases. But that's why it is managed so microscopically. And you're extracting these basis points of alpha in your longs and shorts. And then using leverage. A market neutral is probably 200%, 300 % gross by and large. Long short was always kind of like 50 net, 150 gross, something to that extent. But they're just not as big of a player anymore.

26:02But that's the trick here. When I start seeing it, I always love the systematic stuff because it's so tight in. It It kind of looks a lot like the options market. And market structure, by and large, feeds momentum now, right? You're not scaling out of positions the more they trend. You're loading into them. So whether it's target volatility or CTA, you assign an exposure target, a leverage target. And if the volatility is 5 and your vol target is 10, you've got to lever that two times or 12. And that is, ironically, the lower vol goes, the more you need to add leverage onto that position to match your target.