There has been much concentration over potential market volatility. The causation of the volatility is varied, from systematic imbalances to election risk to bond market shocks. JPMorgan’s Quantitative and Derivatives Strategy Head Marko Kolanovic says don’t worry, be happy. So long as momentum doesn’t reverse trend, the stock market should be good heading into the US election.
Systematic strategies did not fire short stock market bullets
It was a few short weeks ago, on September 7, when Kolanovic, the man who partially called a flash crash, said that stock market selling and volatility was ahead. On that day, with the S&P 500 standing 2186, Kolanovic was looking at troublesome central bank policies and election risk.
It was two days later when the stock market sharply sold off, touching a near-term low of 2127. Volatility, as measured by the CBOE VIX index, woke from a summer slumber to spike from 12 to 18 over a short time horizon.
Kolanovic noted the volatility in the US was less than overseas. During this period S&P 500 price momentum held positive and CTAs didn’t short the S&P 500, he noted.
“As S&P 500 momentum held and short-term volatility stayed below 20% (in part due to VIX investors rushing to sell around half of their long ETP exposure), the amount of equities sold was likely half of what was sold in August/September of last year,” he wrote, noting significant market liquidity during the event.
Kolanovic says stock selling from systematic strategies “is now mostly completed,” but he does so with a significant caveat. “This is assuming that S&P 500 momentum stays positive (most likely, in our view), and that volatility does not significantly increase further (as important central banks meetings are out of the way).”
Election risk – Don’t worry about US elections, Trump victory might elicit a rally
For Kolanovic, the next market catalysts will be found in the US elections and a potential Federal Reserve interest rate hike in December. One of these catalysts has him worried and the other in no longer the concern it was.
The outcome of the US election might not be the negative that other analysts have forecast. Even Kolanovic has gone back and forth on his concern and then lack of concern over the potential election of Republican Donald Trump.
Kolanovic, who thinks the election will be a “coin toss,” looks at a potential Trump victor as not only a market neutral, but potentially positive.
“While the prospect of Trump winning the election may be unnerving for some investors (especially those overseas), we do not think that Trump’s potential win is a risk for equity markets,” he wrote. “In fact, certain structural effects may even result in short-term upward pressure on equities.”
When he looks at the election risk, Kolanovic thinks establishment consensus could be misreading the situation much as was the case over Brexit. “There is a close analogy between Brexit and the US elections,” he wrote. “In the Brexit case, the establishment underestimated the probability of losing the referendum, but overestimated its short term negative consequences.”
The potential for a Trump election win is being underestimated and the negative consequences overestimated. In fact, Kolanovic thinks it could lead to a stock rally. “We do not think the US election should be an impediment for investors in risky asset such as value stocks, commodities or emerging markets,” he wrote.
There are major concerns, they just don’t involve Donald Trump. “We believe the major risk for investors continues to be potential tightening from central banks, high valuations in certain segments of equity markets, and the ‘ageing’ US business cycle.