Needless to say, there was more than a little speculation about whether and to what extent forced selling/de-risking from systematic/programmatic strats contributed to Wednesday’s rout on Wall Street.
Thursday was little better, with selling picking up late-day and snowballing into the close on what Goldman noted Friday morning looked like decreased market depth.
“As would be expected with high volatility, SPX futures’ quoted market depth has been even lower than it was through much of this year”, the bank’s Rocky Fishman wrote in a note out early this morning, before noting that “what was less expected is that futures’ depth worsened on Thursday: in the height of Wednesday’s price action, high volume enabled deep markets; lower volume but high volatility has left low bid/ask depth on Thursday.”
Also on Thursday, Nomura’s Charlie McElligott suggested that CTAs were deleveraging heavily. “Nomura’s Quant Strategies CTA model reduced down to 43% Long from 100% Max Long 1 week ago” by the end of Wednesday, “selling $88B on the 1-day move from 97% Long where we began the day down to said 43% Long”, McElligott wrote.
Fast forward to Friday and the recognized authority on these matters is out with an update.
“Wednesday’s selloff was largely technical in nature, with systematic strategies following the same selling template as in the Feb 5th selloff”, JPMorgan’s Marko Kolanovic writes, in a note out Friday afternoon.
He goes to point the finger at option gamma hedging.
After the clean out, Kolanovic says things should improve – at least from the perspective of systematic selling.
“This risk is now balanced, and can turn into a positive impact”, he writes, before posing the following series of hypotheticals:
For instance, if the market were to hold its gains during the day, it could result in a squeeze higher by end of the day from gamma hedging flows. Other large selling flows were from CTAs that started in indices such as Russell 2000 and Nasdaq last week, eventually spreading into the S&P 500 on Wednesday.
As far as CTAs contributing to Wednesday, Marko reminds you that the trend followers de-risk quickly and thus whatever was going to happen there in terms of forced de-risking, likely already happened.
“CTA selling likely largely behind us given the already low CTA equity beta, and the fact that 12M momentum on S&P 500 will most likely hold positive (>2550)”, Kolanovic says, adding that “the remaining part of systematic selling is from volatility targeting (insurance, parity funds, etc.) which will go on for several more days.”
As far as exactly how much of the systematic selling is in the books, Marko puts that figure at roughly 70%, with possible further de-risking coming from, as noted above, vol-targeting strats. That selling will probably be more spread out, and unless something else comes along to spark a broad-based panic, the market should be able to digest the flows with relative alacrity.
When it comes to what might support equities from here, buybacks of course get a mention. While we’re in “peak blackout” (so to speak), Kolanovic notes that ASR programs are not subject to blackout restrictions.
And then there’s the ubiquitous dip buyers and the pension bid. “Fundamental buyers [may be] attracted by cheap valuation (P/E below historical average), as well as fixed weight portfolio rebalances (e.g. pensions rebalancing on triggers)”, Marko adds.
Obviously the risk is that volatility doesn’t come back down in an environment where a whole lot folks are (still) short vol. either implicitly or explicitly.