Well, Dani Burger is still working for Bloomberg, although I have no idea why after returning 850,000% on her proprietary “cat factor” strat, a feat that by all accounts should have made her the richest person on the planet by a country mile.
Perhaps she’s putting off her new career as a sled dog breeder just to torture Wall Street’s quants for another couple of months.
On Thursday, Dani’s back with a new piece called “The US Stock Market Belongs To Bots“, that underscores a point we and plenty of other folks have been keen on making for some time now.
See the thing is, persistently suppressed vol. allows programmatic/systematic strats (think CTAs, risk parity, and vol. control) to lever up, and there’s a certain self-feeding dynamic to the whole thing. Recall this chart from BofAML:
If you want the full treatment on this including estimates of what would happen if the CTA crowd were forced to delever all at once, you’re encouraged to check out “Investigating The Market’s “Nightmare Scenario.”
It seems highly likely that VIX ETPs are contributing to this dynamic and that, as Deutsche Bank’s Rocky Fishman has noted on more occasions than he probably cares to count, this whole thing could slam into reverse as short covering and buying by levered VIX products could exacerbate a vol. spike and on top of that, the fact that vol. is so low means that an otherwise small nominal break higher would be magnified in percentage terms. Here’s Rocky:
VIX ETPs are a larger-than-usual feedback loop in markets.Inverse and levered VIX ETPs’ need to buy VIX futures when vol is rising and sell it when vol is falling creates a feedback loop in vol that can lead to high vol-of-vol. Currently, the combination of low VIX futures levels (making an N-point vol spike look like a huge percentage), large short ETPs, and large levered ETPs leaves over $70mm vega to buy on a hypothetical 5-vol spike in the VIX futures curve.
Well anyway, the consequence of all this is record equity exposure for quant funds. Here’s Dani and Credit Suisse to explain:
That money you see sloshing around in the U.S. stock market, it belongs to the robots.
At least, that’s the picture emerging from a growing divergence between quantitative funds and discretionary managers. Systematic strategies have barely budged from near-record participation in U.S. stocks. Meanwhile, fundamental equity long-short managers can’t afford to be anything but picky, considering the market’s narrow leadership.
The result: the largest gap on record between humans’ and computers’ gross exposure to U.S. equities, data compiled by Credit Suisse Group AG show. For now, systematic traders are the dominating force in markets.
“This is the largest footprint for quants. It’s a function of allocation and leverage,” Mark Connors, global head of risk advisory at Credit Suisse Group, said. “The reason why that’s important is that they’re not going away. Complexity isn’t going to be rolled back.”
In a sense, the divergence reflects the growing popularity of quant methods over traditional strategies. Nailing down the exact size of the quantitative space is nearly impossible, though some estimates are as high as $500 billion. What’s more certain is that it’s getting bigger. Quant is the fastest growing category on both Credit Suisse’s prime brokerage platform and the broader universe.
Passive and quantitative investors now account for about 60 percent of all equity assets, compared with 30 percent a decade ago, according to data from JP Morgan Chase & Co. The firm estimates that only 10 percent of trading volume now comes from discretionary investors.
Burger goes on to reference the note we highlighted earlier this week from SocGen’s Andrew Lapthorne, who warned that the selling in tech stocks felt a whole lot like systematic deleveraging. Here’s that note for those who missed it:
The big news of the week, of course, came on Friday, with a sell-off in US Technology and related stocks. To give just one example, the Philadelphia semiconductor index (SOX) fell 4.2% on Friday, having at one time been down by more than 6.5%. Numerous technology and internet stocks saw similar performance setbacks.
The sell-offs themselves are not particularly unusual, but the uniformity of the prices moves all on the same day indicates a market driven by price chasing momentum, with investors heading for the door all at the same time. Indeed, those S&P 500 stocks which sold-off on Friday were almost all from the strongest performing decile over the previous 12 months (the r-squared on the S&P 500 line in the chart below is 85%). Within Nasdaq the relationship is even stronger at 95%.
Such a uniform sell-off strikes us as systematic, especially as the relationship weakens once you look at the broader and less liquid Nasdaq composite. For price chasing investors, Friday’s plunge serves as a warning; when it’s time to head for the door, you better move fast.
At the end of the day, you’re encouraged to remember that the most dangerous thing about all of this may not be systematic deleveraging itself, but rather the fear it instills in other investors.
And on that note, we’ll leave you with one last quote, this one from BofAML
When fears of CTAs driving the market lower become a self-fulfilling prophecy. While our expectations of potential CTA equity deleveraging flows may not dominate volumes in isolation, a remaining unknown is the additional selling pressure from investors fearful of these model driven flows.