Or at least that appears to be the message from JPMorgan’s resident “Gandalf”, Marko Kolanovic.
You’ll recall that just days prior to the market meltdown that ended up catalyzing what BofAML guesstimated was some $200 billion in forced selling from CTAs and risk parity, Kolanovic suggested that things probably wouldn’t deteriorate enough to trigger broad deleveraging from the systematic crowd he’s made a name for himself warning about over the past several years. To wit:
Consistent with our previous research, we think that the move was not large enough to trigger broad deleveraging. Equity price momentum is positive and trend followers are not likely to reduce equity exposure.
Obviously, that wasn’t a great call. “Equity price momentum” accelerated dramatically to the downside the very next day when the AHE print from the January jobs report came in well ahead of consensus. Then last Monday, the bottom fell out completely. That ultimately “forced” him to say the following in an “update”:
In last week’s note, we noted that volatility, at the time, was not sufficient to trigger systematic strategy de-risking. On Friday, the market dropped ~2% on a day when bonds were down ~40bps. The move on Friday was helped by market makers’ hedging of option positions (as gamma positions turned from long to short midday). Friday’s move, on its own, was significant as it pushed realized volatility higher, which is a signal for many volatility targeting strategies to de-risk.
Further outflows resulted from index option gamma hedging, covering of short volatility trades, and volatility targeting strategies. These technical flows, in the absence of fundamental buyers, resulted in a flash crash at ~3:10 pm [Monday]. At one point, the Dow was down more than 6%, and later partially recovered. After-hours, the VIX reached 38 and futures more than doubled.
Fast forward to last Friday and we got this from his colleague Nikolaos Panigirtzoglou :
That right there is what many people speculate might have catalyzed the late Friday ramp that set the stage for this week’s buying spree.
Well this afternoon, Kolanovic is back and he’s still some semblance of bullish. To wit:
Global equity markets tumbled last week and volatility rose sharply. In last week’s Market and Volatility Commentary, we advocated buying the dip as the drivers of the sell-off were entirely technical in nature and equity fundamentals remain strong, and markets have since recovered more than half of the sell-off. The sell-off was driven by a waterfall of selling flows from systematic strategies (Vol Targeting funds, CTAs, and dealers hedging short gamma exposures) triggered by the rising volatility and bond/equity correlation, and reversal in momentum, as well as fundamental investors who sold in anticipation of these flows and due to weakened sentiment.
With nearly all of the required de-leveraging by systematic investors behind us, we believe markets should continue to recover. Further, systematic investors could begin to re-lever equity positions as momentum is positive at all but short-term horizons (allowing CTAs who were stopped out on the sharp sell-off last week to reenter longs) and realized volatility begins to decline (causing Volatility Targeting funds to gradually re-lever).
There you go. Last week’s forced systematic unwind is next week’s tailwind as the deleveraging offer turns into a re-leveraging bid. Or so says JPMorgan.
Here’s what they’ve got to say about VIX positioning one week on from Vol-pocalypse:
Equity-implied volatility spiked on the sharp market sell-off, with the VIX recording its highest levels since the Aug’15 market crash. Notably, the sharp spike in VIX futures on the evening of Feb 5 nearly wiped out inverse VIX ETPs. These ETPs deliver daily inverse leverage to a rolling 1M VIX futures strategy and thus see their NAV fall to zero (or go negative) if the underlying VIX futures double or more within a single day. On Feb 5, VIX futures spiked ~96% into the futures close at 4:15pm due to the combination of the market impact of these and levered long VIX strategies (which need to buy VIX futures to rebalance into the close when they’re up), anticipatory flows, and weak market liquidity.
We note the drawdown in these products represents a permanent impairment to the strategy, and investors shouldn’t look for a return to previous trading levels even as volatility continues to fall. For example, SVXY peaked ~$138 in mid January and is currently trading ~$13—if the one-month weighted VIX future were to fall ~35% from the current level (~17.5) back to the same level as it was trading in mid January (~11.5), SVXY would only rally to ~$17.503 (i.e., 13 x 1.35) and would still trade ~87% below its recent peak.
In other words: if you’re buying SVXY thinking it’s going back to where it was, you’re going to be sorely disappointed.
Ok, so what about dealers or, more to the point, are they likely to exacerbate or cushion a selloff going forward? Here’s Kolanovic:
As we discussed in last week’s notes, dealers turned materially short gamma during the Feb 5 sell-off, and their hedging activity helped boost volatility and contributed to the strong sell-off on several days last week (Figure 9). As the market recovered this week, the S&P 500 put call gamma imbalance has shrunk, though it will remain largely unchanged after today’s expiry. Dealers appear to remain moderately short gamma at the moment, but the short gamma kicker to the market could fade if we continue to rally. However, dealers are unlikely to go substantially long gamma given strong investor demand for calls, and CTAs are effectively trading “short gamma” as they would likely re-lever on a continued rally.
There’s more, but the takeaway is as noted above. Basically, Kolanovic is out reiterating what Panigirtzoglou said last Friday. Namely that with the forced de-leveraging by systematic investors out of the way, you’ve got the green light to buy the dip.
And straight from Gandalf, no less.