In a matter of moments, the Dow Industrial Average went from being down, 500 points, to 800 points, to 1,000 points, to 1,500 points – marking the largest intraday point drop in Dow History (although just the 33rd biggest percentage drop). While the dust has yet to settle – just two days in February are looking to wipe out all of the monstrous bull run from January, with equities going negative on the year.
The Josh Browns of the world will tell you: don’t panic, this isn’t the time to act. Pulling out now and showing a loss of confidence in the markets will just cause more declines and the cycle continues. But there’s sure to be those signing REM’s “It’s the end of the World” when faced with one day losses such as this… especially those short vol. Of course, those in the Managed Futures / Macro space are usually singing the second part of that end of the world refrain when market crisis periods show up – saying ‘I feel fine.’
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The managed futures space might not be singing that ‘I feel fine’ refrain this soon, however. As we touch on in our Managed Futures / Global Macro 2018 Outlook, the asset class now includes, in a bit of a contradiction, a record amount of short vol. For those who’ve added short vol as a means of capturing some yield while waiting for an increase of record low volatility readings – this spike won’t be leaving them feeling fine any time soon. Early reports from some of the vol traders we track show mixed results, from no positions on today, to down 13% or so, to up (having come into the day long vol!).
Similarly, most trend following type managers were positioned long equity markets coming into February. Here’s Goldman via ZeroHedge explaining just how much long equity exposure.
SYSTEMATIC FLOW UPDATE…
*our (GS systematic strategist) work suggest that the 2,735 level in the S&P is where trends could start to change, driving more aggressive selling from the CTA community. We estimate this community to be long approximately $70bn of US equities and $190bn globally coming into today. If negative price action continued or worsened, we think getting flat (i.e. $190bn of global sales) in a month is reasonable
That’s a lot of Billions selling equities, and a breach of monthly lows, moving averages, and Bollinger bands are just the sort of thing which will trigger such selling among the CTA space. Not to mention the possible unwinding of short bond positions and long energy positions – which have both reversed course alongside equities. The immediate aftermath of this sell off and resultant market reversals is likely a give back of January profits for the managed futures space.
But here’s where we separate from equities. Because if this truly is the end of the world as we knew it (record low volatility for a record long amount of time); that’s not so great for equities (although they could move higher even in a higher volatility environment) and typically a good thing for managed futures (even if the first innings of the sell off/reversal are painful). The Billion dollar question is whether this signals the lasting unwind of the 2017 compression in the markets – or whether this sell off will be bought into and vol sold into just like we’ve seen time and again over the past few years.