If you’re looking for a reason to fret about an extension of last month’s equity selloff, positioning shouldn’t be your top concern.
As summer wound down, a months-long grind higher in stocks on small daily moves led to a steady buildup of exposure from some systematic cohorts. Discretionary positioning was already elevated (on some measures) after climbing steadily during the post-pandemic rally.
Over the same period, rock-bottom realized vol made for a somewhat disconcerting juxtaposition with various “crash” metrics. Finally, the S&P snapped a lengthy streak without a 5% pullback, pushing up realized, which in turn triggered deleveraging from the vol control universe.
On Nomura’s estimates, the vol control de-allocation summed to -$95 billion in S&P futures over the past month.
“Over the last month, volatility increased and there was a meaningful de-risking of systematic and discretionary managers,” JPMorgan’s Marko Kolanovic said last week, noting that leverage in systematic strategies fell from ~75th to ~45th%ile, while hedge fund betas dropped to average historical levels.
A gauge of positioning from Deutsche Bank tells a similar story. “Our consolidated measure of equity positioning has fallen over the last few weeks from the top of its band to neutral,” the bank said, in a note dated October 8.
As the figure on the right shows, systematic positioning is now in just the 39th%ile historically.
“Vol control funds cut equity exposure notably during the last week of September as both implied and realized vols rose,” the bank’s Parag Thatte and Bink Chadha said, adding that “they have maintained those levels (31st%ile) since then as implied vol fell but realized vol rose.”
You can plainly see the uptick in realized (figure below) but note also that it’s leveled off.
“It will get increasingly difficult for index-level rVol to stay ‘up here’ moving forward without sustainable 1.5% daily swings,” Nomura’s Charlie McElligott said Tuesday, reiterating that eventually, it’ll likely “collapse under its own weight, while ‘vol softening’ will only accelerate ‘short vol / hedge monetization’ behavior, which then furthers ‘virtuous’ re-leveraging / re-allocating from the Target Risk / Vol Control space.”
That’s a familiar dynamic to regular readers. Charlie noted Tuesday that both one-month and three-month are starting to “stall and roll.”
The overarching point is just that from here, the market will likely need a fundamentals-based catalyst to extend the selloff. You often hear “positioning is cleaner” after pullbacks when folks are rationalizing a constructive take or otherwise trying to look on the proverbial bright side.
That’s where we were coming into this week. As Deutsche Bank put it, “with positioning at neutral, it is no longer an argument by itself for a further selloff in the absence of clear catalysts impacting the fundamental outlook.”
A bond hedging friend and I both think something is amiss in the financial markets. I do not see how the US $ (DXY) can continue to grind higher and commodity prices contine to be elevated. Something has to give. The Fed has been pretty up front about tapering soon. Meanwhile the ECB and BOJ continue to look at ways to supply liquidity. (BOE is in the Fed’s camp but is smaller than the other 2 central banks). China will also be growing more slowly with their real estate debacle just starting to metastasize- they are easing. If we get a break in commodities, watch the curve flatten more, and the inflation narrative is going to go right out the window. If that happens the vol control universe will be the least of our worries.
Why would dollar strength and commodity appreciation be mutually exclusive?
With the expectation of higher interest rates, the dollar strengthens (appreciation relative to other currencies). With the expectation of scarcity of commodities, their prices go up in all currencies. If the dollar is strengthening, perhaps the prices don’t go up in dollars as much as in other currencies, but there’s nothing that limits that appreciation besides an increase in supply or a decrease in demand.
With all the newly printed monies slushing around and making their way into the plumbing of the world economy, commodities can keep appreciating. In the game of international musical chairs, whoever is able to tighten last gets the most oil : )