Warnings that computer-driven investors could ignite crashes in stocks with robotic selling in coming weeks are simplifications that fail to account for precautions the funds take to lessen their impact, according to Societe Generale SA.
Responding to research Thursday by JPMorgan Chase & Co., Kokou Agbo-Bloua, a strategist for Societe Generale in London, said it’s unlikely the American stock market would repeat its tumble from Monday, when the Dow Jones Industrial Average fell more than 1,000 points in minutes.
Plunges may recur in coming weeks as quantitative funds adjust their portfolios after Monday’s volatility and unload as much as $300 billion in stocks, JPMorgan’s Marko Kolanovic said in a note Thursday. But the shock of the last few weeks has left investors on high alert — too high, in Agbo-Bloua’s view — for the market to be blindsided again, at least in the absence of some larger trigger.
“We’d take the opposite view,” Agbo-Bloua, the global head of engineering and strategy for Societe Generale, said by phone. “You need a preset of conditions before these volatility or trend-following factors are relevant. We should differentiate between the cause of the selloff and factors that make the selloff worse. They’re not the drivers, they’re the amplifiers.”
Everyone has a theory on what drove U.S. equities down this month, some focusing on China and the Federal Reserve while others seek causes among players in the all-electronic U.S. stock market. While program traders have the firepower to influence trading, they’re operating in a market where more than $400 billion has changed hands each day this week.
Concern over China’s policy, fears of slower global growth, and lower oil prices triggered the selling in the last few weeks, while low summer volume from fundamental investors made it worse, Agbo-Bloua said. It’s unlikely this exact set of conditions will repeat. Looking ahead, volatility in markets will hinge more on what the Fed says at its next meeting, he said.
Quantitative funds take steps to mitigate their own impact, such as reducing leverage and attaching circuit breakers to their programs, according to Agbo-Bloua.
“Once there’s been a selloff, those who had to cut positions are done,” Agbo-Bloua said. “When you get stabilization, that means there’s been a clearing. Those who got burned were able to unwind their positions pretty aggressively so you see a period of calm.”
While China and a potential Fed rate hike have been blamed for the recent volatility in stocks, price swings have been made more extreme by traders who are insensitive to the value of stocks, JPMorgan’s Kolanovic wrote.
Funds employing three types of quantitative strategies specifically — trend followers, risk parity traders and funds that adjust holdings when volatility in the market rises or falls — could force up to $300 billion of selling in the U.S. market over the next several weeks, according to his note.
Calls and an e-mail to Kolanovic asking for his response to Agbo-Bloua’s comments were not returned.
An index that tracks the total value-traded in U.S. stocks spiked on Aug. 24 to $630 billion, the highest since 2008. That’s after averaging about $271 billion all year, signaling there was pent-up selling pressure building up before the rout that day.
Systematic traders have exacerbated volatility in not just stocks, but in the currency and bond markets also this year, according to Danske Bank A/S’s Allan von Mehren. While there’s been focus on low liquidity, funds that trade purely on technical signals have also contributed to moves, he said. When these systematic funds receive a sell signal, they exit immediately and automatically. If liquidity also isn’t good, it magnifies the swings.
“Normally, if you’re a portfolio manager and you want to buy a stock or reduce exposure, you do it gradually and decide on price levels, but these types of funds react mechanically,” said Von Mehren, a Copenhagen-based chief analyst at Danske. “We saw the same thing with the Swiss franc in January — the price move was enormous in a very short time. We saw it in the bond market this year. We’ve seen moves over a week that you typically don’t see for decades. And now we’re seeing the same thing in the stock market.”
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