JPM Head Quant Warns Of “Catastrophic Losses” For Short Vol Strategies

Jon Banking

It has been a while since we heard from JPM’s quant guru, Marko Kolanovic, who following the recent FANG crash and quant rotations and ahead of this Friday’s massive S&P op-ex, has published his latest latter, covering everything from the aforementioned market moves, to the ongoing drastic changes in the market structure, to the prevailing low levels of volatility despite the sharp market selloff on May 17 (with no follow through), and finally concludes with his latest near-term market outlook.
First, when it comes to overall market topology, it should come as no surprise that in a world increasingly dominated by passive strategies, quants and algos, Marko first highlights the significant changes in market structure, of which he writes that “stocks are increasingly caught in powerful cross-currents of passive and quantitative investors.”
First, some striking facts: to understand this market transformation, note that Passive and Quantitative investors now account for ~60% of equity assets (vs. less than 30% a decade ago). We estimate that only ~10% of trading volumes originates from fundamental discretionary traders. This means that while fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock-specific fundamentals.
The next, and perhaps just as important driver is, of course, central banks: “With ~$2T asset inflows per year central bank liquidity creates strong interest rate and policy sensitivity for sectors and styles. Low rates also invite investors to sell volatility.”
Discussing the recent shift in market correlations, which have become increasingly volatile, Kolanovic notes that their “interpretation has changed.” According to the JPM quant, historically, low correlation meant that stocks were driven by company-specific fundamentals – an environment in which fundamental investors thrive. Now, however, while correlations are low, it is for different reasons – large sector and style rotation driven by quant flows, monetary policy and political developments (e.g. growth-value, low volatility-high volatility, ‘Trump trade’ and its unwind), something we have repeatedly demonstrated over the past month courtesy of the work of RBC’s Charlie McElligott.

This post was published at Zero Hedge on Jun 13, 2017.