Nervous about all the volatility? One of Wall Street’s most cited observers of market volatility says not to worry.
Marko Kolanovic, the global head of derivatives and quantitative strategies at J. P. Morgan, says that while the market turmoil is unsettling, “the current selloff is entirely technical in nature, that fundamentals did not change, and as such that we believe that it is an opportunity for human investors with some tolerance for market volatility to step in.”
What caused the problem? Kolanovic points the figure at a stew of trading strategies (short VIX, realized volatility, price momentum) that together created “the collision of selling from various systematic strategies, and diminished equity liquidity provided by electronic market making in times of stress will produce liquidity crises.”
We have long discussed the end of the short volatility/long stocks trade as the biggest culprit for the market volatility this week, but Kolanovic throws in another factor. “Electronic market making depth becomes severely diminished at the same time these signals are triggered.”
That swipe at market makers, naturally, doesn’t sit very well with market makers. Doug Cifu, CEO of Virtu, one of the world’s largest market makers, said, “While Kolanovic has some interesting and intuitive ideas around macrotrends, his understanding of micro market structure is limited”
And those who engage in the type of trading strategies that Kolanovic singled out as a factor in the trading don’t like the swipe either. Cliff Asness, head of quant fund AQR, took the time out to write a letter that said, in effect, don’t blame us. “It takes an awful lot to move big global stock markets and the sizes and trading speed of risk parity and trend-following strategies just don’t get you there.”
Asness went even further, claiming that the estimates about the size of the trading in these strategies were simply wrong: “Once a bad story gets out there, particularly one appealing to people’s fears of ‘the machines’ and other nasty things, it’s very hard to stamp it out.”
Still, traders are nervous, because there has been very heavy selling in the middle of the day three out of four days this week, and it seems clear someone is deleveraging. Asness insists it is just nervous humans. “We are inclined to blame those fickle humans who actually sometimes just change their mind about the right price to pay for stocks and, in the words of a famous fund manager, become the real ‘hammer on the downside.'”
Regardless. Kolanovic is optimistic because the fundamentals are so strong.
“[G]lobal growth is very strong, US corporate earnings are at record highs (and continue to be revised higher), commodities have stabilized, and the USD is weak,” he said. “We also want to add that the new Fed chair, vetted by the current administration that uses the stock market as a score card, is highly unlikely to do anything to derail markets and the economic cycle. All of these factors make a big difference, and should give confidence to fundamental investors to step in and short-circuit the feedback loop of programmatic selling and depleted equity liquidity.”
He also notes that stock market valuations are now much lower (and close to historic averages).
But what about the big question: When will all this de-leveraging end? No timetable, but he confidently states that “substantial de-risking already took place.”