"What Might The Market Do Next?" A Bullish Marko Kolanovic Answers
The past month has been mixed for JPM's head quant, Marko Kolanovic.
On one hand, just days before the Feb 5 quant puke, he published a report, predicting that the late January selloff would not lead to widespread systematic liquidations. A few days later, on "Volocaust Monday", that's precisely what happened and to a never before seen extent.
Then, in keeping up with his recent cheerful outlook, shortly after the selloff, Kolanovic doubled down, and said that after the initial deleveraging of quants, vol-sellers, CTA and risk parities, the forced selling is now over and it was safe to buy the dip. Here, his call has been far more accurate, as almost nothing is left of the early February 10% correction following a barrage of BTFDers.
In fact, the speed of the rebound appears to have surprised Kolanovic himself, and in his latest note, published moments ago, he writes that the subsequent one-week rally was very fast (~99th percentile one-week up move vs. S&P 500 trading history).
As such, "the question is: What might the market do next?"
To answer this question, Kolanovic first looks at his favorite indicator, capital flows, and specifically "the positioning of investors and expected flows", especially among the systematic, vol-targeting funds.
First, we note that the Hedge Fund beta to equities experienced an unprecedented drop over the market sell-off (Figure 1). This de-risking (and in some cases shorting) happened largely via buying of downside options (and selling of index products) and might not be entirely captured by prime brokerage data. For instance, open interest on index put options rose by ~$500bn shortly after the sell-off. Hedge funds went from a near-record-high equity beta, to a near-record-low equity beta.
This move started to revert last week, but has plenty of room to increase (table in Figure 1). In terms of systematic selling, this is largely over. In fact our models show that volatility targeting strategies may now start very slowly rebuilding their equity positions.
Then there is the potential bid from pension funds, whose rebalancing at the end of the month could make for a rare buying imbalance, something we discussed two weeks ago in "An Unexpected Consequence Of Last Week's Selloff"