On Tuesday, JPMorgan’s Marko Kolanovic suggested that after October’s abysmal performance in U.S. equities, stocks could be in for a “rolling squeeze higher”.
That was at roughly 10:15 on Tuesday morning. Since then, stocks are up more than 2.5%. My guess would be you won’t hear much from the bearish peanut gallery, let alone from any newly-minted Kolanovic critics, on that point.
Anyway, part of the rationale for Marko’s call was re-risking from systematic investors whose exposure to equities plunged in October. “Volatility targeting strategies’ equity holdings are similar to February lows, and many CTAs are outright short or out of equities”, Marko wrote, before suggesting that if “volatility [were] to decline into year-end, [it] should prompt systematic investors to re-build equity positions to the tune of ~$100 billion.”
That was but one of several factors Kolanovic cited and obviously, re-risking from the systematic crowd won’t happen all at once, but in the context of that call, the following excerpt from Nomura’s Charlie McElligott is notable (this is from his Thursday note):
This U.S. Equities “gap higher” (S&P minis +4.8% since Monday night’s low-tick) ultimately has forced incremental Systematic fund RE-leveraging in U.S. Equities—the Nomura Trend CTA model shows SPX positioning now “+60% Long” from “+31% Long” two days ago; Russell to “+60% Long” from “-100% Max Short” last week; and Nasdaq to “+60% Long” from just “+31% Long” yesterday.
As ever, we would remind folks that if you’re going to flag the impact of these flows during selloffs, you have to also be mindful of how they contribute on the upside. That’s something the likes of McElligott and Kolanovic have no trouble doing (indeed, that’s their job), but I’d be willing to bet that most readers have noticed a remarkable propensity over the past year or so for bearish commentators (bloggers and otherwise), to scream from the rooftops about systematic de-risking only to go completely quiet when it comes to systematic re-risking.
In his Thursday missive, McElligott also touches on what he calls “a hotly-debated topic now in the business”. That topic: The propensity/ability of funds that were torched last month to go on the “offensive” and thereby provide an incremental bid for equities going forward. This is an extension of the discussion around the egregious hit discretionary funds took in October.
“The underperformance/shock drawdown within the U.S. Equities fund space weakens the basis for performance-chasing mentality into year-end as sentiment pivots to defense from offense, with little-to-no ammo across the generic fundamental/discretionary Equities space”, McElligott wrote in his Wednesday note.
Well, on Thursday, he picks back up on that debate on the way to positing a theory about what’s been going on over the past several sessions.
“SPX continue to trade like there’s an implicit and incremental source of short gamma in the market [and] that short gamma source would likely be contained within the fundamental universe, both HF and MF, who are not actually short option delta per se, but are increasingly likely to act as forced buyers the higher we travel”, Charlie writes, before making the obvious connection with the October narrative as follows:
This is occurring after the 1) “mass de-gross / cutting of nets” and 2) enormous reduction of “market” factor risk exposure of the past month. “Beta” market-neutral was -10.9% in Oct despite including yday’s +2.9% rally—nonetheless the sixth worst month for the factor since 2010—as crowded portfolio positioning “long high beta / short low beta” was liquidated.
McElligott is basically – and he says this – arguing that with macro funds and trend followers re-risking, building exposure and just generally getting long, hedge funds are getting left further in the dust.
“They’re de facto getting shorter the higher the market moves in their absence”, Charlie says, adding that in his mind, “they are ‘dynamically hedging’ with spastic trading in Spooz as opposed to options due to their richness right now.”
So there’s a handy explanation for you if you’re inclined to characterize the last couple of days as “spastic.”