Outside of oil, markets are making an effort to normalize.
That makes markets not much different from humanity. It’s all about the normalization process or, at the least, drawing a map that will get us back to “normal”.
In this regard, every incremental piece of news that suggests some country, state or even city/town is taking steps to reopen will be seized on by someone, somewhere as another piece of the puzzle which, when it’s all put together, will show equities back near pre-COVID levels.
Or at least that’s the plan. And you know what they say about the “best-laid plans”, right? Something about how they never go awry.
In any case, Nomura’s Charlie McElligott on Tuesday continues the discussion from last week around the the gradual return of key flows which together help perpetuate the virtuous loops that make for calm, steady grinds higher.
“We have noted the return of heavy Overwriter (vol selling) flows in US Equities over recent weeks, which has accelerated the normalization in US Equities single-name and index Vols”, Charlie begins, adding that “now, with the VIX curve term structure too normalizing from the multi-month inversion in the front-end, it’s likely that the return of systematic roll-down participants will further escalate the repricing/compression of vol even lower”.
(Nomura)
That, of course, opens the door to reengagement from key systematic flows. As vol normalizes, the vol.-targeting universe will begin to mechanically re-leverage after reaching the “nothing left to sell” point amid the rout.
On Nomura’s estimates, we’ve already seen nearly $15 billion in incremental “re-buying” (if you like) from vol.-control over the past month.
Perhaps even more notable, though, is that CTAs may be on the brink of flipping back long in the S&P, the global risk asset bellwether par excellence.
“Our Nomura QIS CTA Model estimates that the position in S&P 500 futs would flip from ‘-69% Short’ to a ‘+100% Long’ on the close above 2901 (ref spot @ 2905!)”, McElligott writes, on the way to noting that “anecdotally on these days where the model indicates a ‘flip’ potential, said buying to cover and go long is likely already part of the flow “.
It’s worth noting that on April 13, JPMorgan’s Marko Kolanovic flagged the same levels.
“Investor positioning remains light. Hedge funds are positioned defensively with an equity beta in the ~10th %tile, and systematic investors’ exposure is near the bottom of its historical range”, Marko wrote.
“CTAs would be covering shorts/buying long if the S&P 500 reaches ~2900 [and] volatility-targeting funds will start adding equities as volatility declines. Initially this would be at a very slow pace”, Kolanovic went on to say. “Given the Fed’s corporate bond backstop, we believe the VIX should follow credit spreads lower”.
And so it was.
The levels for CTA re-leveraging highlighted here can easily be triggered today, bye bye negative gamma, economic reality be dammed
This is a great post and very insightful. I have been seeing the same things in my risk models. I took off some risk about 3% ago in the stock market. It was the right thing to do for my client base but I can totally see with my own eyes with my own risk models what is happening. As the Vix or other volatility goes down, your risk model will tell you that you are underweight risk and encourage you to buy- if you closely follow your models. This rerisking will continue until either another headline comes out or sentiment somehow changes. This is a trend following phenomena, and it works well in linear markets, as long as the market is functioning and there is a trend. Much like a momentum strategy in stocks.
Dancing around the music of fantasy earnings and listening to Pied Piper hype is a truely dangerous game. If you’re willing to look past earnings, accounting and reality, now is a great time to follow other lemmings!
So now that we closed a hair under 2900, is the releveraging in play?
Jez, parsing Charlie M’s words very carefully, it sounds like the true “flip” trigger occurs at 2901 Futs/2905 Spot GOING INTO THE CLOSE. Obviously, SPX faded lower throughout the day (Tuesday 4/28), closing @ 2863. But, the big gap higher AT THE OPEN (2910-ish) may have been the CTA’s beginning their covers, only to abandon the effort as SPX faded lower (…Charlie M noted that the CTA’s may try to get a head start on their covers on days where a flip at the close is within reasonable range).
As I write this, Futs in the Asian time zones are higher at 2895, so maybe Wednesday might be “flip day” ?
As the orange balloonhead likes to utter: “We’ll see what happens”.