JPMorgan's Kolanovic Says Some Systematic Strategies May Sell at the LowsBy
Some market action playing out similarly to August 2015
Outflows likely to keep investors on edge for several days
Sell low and buy high... wait, is that the way it’s supposed to go?
Once bumpiness had flooded into the market, various forms of volatility-targeting strategies were set in motion and added to outflows that will keep investors on edge for several days, JPMorgan strategists Marko Kolanovic and Bram Kaplan wrote in a note Thursday. Some systematic strategies may end up selling at the lows and later buying back at the highs, they said.
“Strategies that are selling are those that use realized volatility, correlations, VIX and price momentum as signals to adjust exposure,” the report said, noting that assets under management in those areas have increased greatly in the past decade, to what they estimate is now about $300 billion. “On the other side, electronic market making depth becomes severely diminished at the same time these signals are triggered.”
The report said that in terms of systemic flow and electronic liquidity, the current market moves are playing out the same way as in August 2015.
“It started with the de-risking of trend followers, short volatility positions, and strategies sensitive to bond-equity correlation. Similar to Aug 24th, by far the largest and quickest punch came from hedging flows for the trillion dollar+ S&P 500 index put option complex (gamma hedging) on Monday, and was compounded this time with liquidations in the VIX complex. As this was unfolding, electronic liquidity, in the once-most-liquid product, S&P 500 e-mini futures, evaporated.”
Still, JPMorgan sees a big difference with August 2015 as well.
“While for equities this looks like a 2015 type of crisis, other asset classes disagree. This is because there is a big macro/fundamental difference between now and the August 2015 market crisis,” they said. “In 2015, we dealt with an EM crisis (e.g. China), crisis of credit spreads, collapse in commodity prices, and weak global growth. There were legitimate fears of a global recession. Now, the situation is exactly the opposite: global growth is very strong, U.S. corporate earnings are at record highs (and continue to be revised higher), commodities have stabilized, and the USD is weak.”
“All of these factors make a big difference, and should give confidence to fundamental investors to step in and short-circuit the feedback loop of programmatic selling and depleted equity liquidity,” the strategists said.