The Next "Significant Risk For The S&P 500" - Kolanovic Reveals "The Macro Momentum Bubble"

Tyler Durden's picture




 

Yesterday when we presented Tom DeMark's latest technical forecast, which anticipates a 5-8% bounce in risk before the next leg lower in equities, we said to "look for the next few days to see if DeMark still has his magic" adding that "we, on the other hand, would rather wait for "Gandalf" Kolanovic' next take."

We didn't have long to wait: moments ago JPM's head quant, whose uncanny track record of predicting every major market inflection point has been duly documented here, laid out his latest thoughts on the negative feedback loop that is "becoming a significant risk for the S&P 500" but also showed what he thinks is an odd divergence between various asset classes, to wit: "as some assets are near the top and others near the bottom of their historical ranges, we are obviously not experiencing an asset bubble of all risky assets, but rather a bubble in relative performance: we call it a Macro-Momentum bubble."

His warning: beware the bursting of the macro-momentum bubble.

Here is the latest warning from the man whose every single caution so far has played out virtually as predicted:

Macro Momentum Bubble

 

In our report last week, we argued that the chance of a bear market is much higher than the market expectation at the time (our estimate ~50% vs. options implying ~25%) and recommended increasing allocations to gold and cash. Over the past week, S&P 500 took another leg lower—and now we believe the market prices a ~50% probability of a bear market. While systematic strategies de-levered more than 2/3 of their exposure (as compared to August/September), market sentiment remains bleak, and there is no obvious catalyst to drive market higher. Short option positions increase market volatility and intraday market moves. The large S&P 500 intraday selloff yesterday was likely driven by gamma hedging (there’s a large put-call gamma imbalance of $25bn per 1%). As we wrote in our report last week, significant short gamma positions are in the 1950-1800 range, and decline below 1800 (on account of put-spreads, where clients are short lower strike puts). As the market fell close to 1800 yesterday, declining gamma near 1800 could have contributed to the sharp intraday reversal.

That was then, and played out just as Kolanovic predicted: here is the latest warning:

At this point we think that the negative feedback loop between market performance, volatility and the real economy (wealth effect) is becoming a significant risk for the S&P 500. To stabilize equities one would need a strong catalyst such as the Fed turning significantly more dovish (or even launching another round of easing). This could put the dollar rally into reverse, stabilize commodity prices and put a floor under the S&P 500. The S&P 500 selloff may also be the catalyst for a momentum– value convergence, which we advocated in our 2016 Outlook (e.g., Oil – Equity convergence).

 

Going into 2016, many investors were wondering if the monetary easing over the past 7 years inflated a bubble in risky asset prices. The answer to this question depends on which risky asset one looks at. In fact, while some assets are near their peaks of historical price and valuation levels, others are near their lows. Since the last bear market 7 years ago, the S&P 500 is up ~200% and still near  all-time high levels. The US Dollar Index (DXY) is also at its highest point in 15 years (since the tech bubble). On the other hand, a large number of risky assets are in the opposite situation: Emerging Market equities, EM Currencies, Commodities are currently trading below levels during great recession of 2008/2009. This unprecedented divergence (more than ~3 standard deviations) is shown in the figure below (also see our 2016 Outlook). Figure 1 shows price of several Momentum assets (S&P 500, S&P 500 Low Volatility Index, S&P 500 Software Index), and Value Assets (EM Currencies – JPM EM FX Index, MSCI Latin America Equities and Commodities – BCOM Index). The left Figure below illustrates that since the onset of the 2008 crisis, the price of Momentum assets increased to 500%, 600%, or even 700% as expressed in units of Commodity prices (BCOM Index, and we observe a similar appreciation in units of EM FX or EM Equities). In summary, as some assets are near the top and others near the bottom of their historical ranges, we are obviously not experiencing an asset bubble of all risky assets, but rather a bubble in relative performance: we call it a Macro-Momentum bubble.

Why do we have this bubble?

Every asset trend starts with fundamental developments. As the US was the first to get out of the global financial crises of 2008-2011 (with Europe and Asia lagging), US assets such as the S&P 500 and USD started outperforming international assets. Divergence between Central Bank policies triggered the USD rally, cross-regional capital flows, and put pressure on EM economies, Commodity prices and Commodity related Developed Market Equity sectors. However, we think that fundamentals were only one of the drivers, and that structural reasons played an equally important (or bigger) role in the creation of this relative performance bubble. These structural drivers are listed and explained below.

 

Diagram above right shows a hypothetical performance of 2 assets: one with positive momentum and another asset whose price declined below some long-term valuation level. As the price of the trending asset increases, its volatility declines. Similarly, the volatility of the ‘value’ asset increases as the price moves lower. Based on this pattern, most risk models would increase the weight of  the trending asset and decrease the weight of the value asset, reinforcing the divergence. Many systematic strategies (such as CTAs, Risk Parity/Vol Target, Low-vol Risk factor portfolios) would do the same. The positive feedback between inflows and low volatility eventually increases the crash risk for trending assets.

 

We think S&P 500 momentum turning negative this year (after a 6-year rally) may be the first step of the mean reversion we expect to play out later this year. Mean reversion would lead to the outperformance of Emerging Market stocks, Commodities, Gold, and the Energy Sector, and relative underperformance of Momentum assets such as USD, S&P 500 Low Volatility and Momentum portfolios, and likely the S&P 500 itself.

 

Below we list and explain several structural factors that led to Macro-Momentum bubble:

 

Explicit Trend Following Strategies: Assets in strategies that explicitly follow price momentum experienced double digit growth over the past few years, and currently stand at over $350bn. This includes CTAs, but also in-house managed pension assets, dealers’ structured products, etc.

 

Implicit Trend Following Strategies: Many systematic strategies bias towards momentum assets. Historically, assets with strong trends exhibit lower volatility and lower correlation to other assets, and are over-weighted in risk budgeting frameworks such as Risk Parity and Volatility Control. In addition, Low Volatility/Smart Beta strategies often overlap with Momentum investing. Over the past year we saw a significant increase in these assets, with the asset base likely topping $1Tr.

 

Macro HF bets are aligned with Momentum bets: Over the past years, many popular macro trades (long USD, short Oil and Gold, long DM and short EM equities) are closely aligned with simple trend following signals. The more recent trades betting on HY defaults or breakdowns in EM currency pegs, also align with recent price momentum (USD up, Oil down, etc.)

 

Volatility based risk management: Many risk management tools refer to historical covariances to determine asset allocation. This approach prefers momentum assets (that have lower volatility and average correlation) over value assets.

 

Decrease of active assets and increase of passive assets: Active equity managers tend to have a value bias, while capitalization based passive indices tend to have a momentum bias (e.g., they increase the weight of stocks that outperform). The shift from active (e.g., seen from persistent mutual fund outflows) to passive assets (particularly ETFs) may have contributed to the underperformance of value and outperformance of momentum in equity long-short portfolios.

 

Higher cost of capital for Value assets: Value trades require more capital than Momentum. Given higher volatility, value assets tie up more risk capital for longer periods of time (momentum tends to work on shorter time horizons, and value/reversion on longer time horizons).

 

Lower liquidity of Value assets: Value assets, being more volatile than momentum assets are also less liquid. Since financial crisis, both investors and market makers are averse to hold and provide liquidity of less liquid assets.

So now we know that we have not one massive bubble, but a bubble of small asset-class divergences, all thanks to the Fed. What to do? As a reminder, here is how JPM's will trade this: use transitory bounces to liquidate risk positions, and stay in either cash or gold until better buying opportunities present themselves.

Unless, of course, Yellen launches QE4, in which case all bets are off.

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Thu, 01/21/2016 - 12:01 | 7077535 Father Thyme
Father Thyme's picture

Positive reinforcement: engage!

Thu, 01/21/2016 - 12:05 | 7077547 hedgeless_horseman
hedgeless_horseman's picture

 

 

Look at the swings and volume in WTI and Brent!!!! 

The currency war is heating up.

Thu, 01/21/2016 - 13:46 | 7077974 mandalou
mandalou's picture

I would ask Kolanovic how can mean reversion in his theory exist if QE is always lurking or in action?

Look at the SP 500 since QE began. There was not mean reversion nowhere to be seen. Everytime the market attempts to prove if Mean Reversion is true, it reverts back to its QE path. Hell, maybe I am looking at this wrong but when he says mean reversion, I immediately wondered how he can base his calls on a theory that has been proven wrong time and time again with central banks.

Thu, 01/21/2016 - 13:55 | 7078027 Chupacabra-322
Chupacabra-322's picture

Theoretically, this Criminal Fraud can perpetually continue so as long as the Central Banks continue to print money.

Thu, 01/21/2016 - 14:00 | 7078050 mandalou
mandalou's picture

agreed which is why he is expecting a turn because of mean reversion yet hints if QE is a coming then mean reversion does not exists. Basically mean reversion works if price goes down a lot and it is just a theory if the FED QE4LIFE.

Thu, 01/21/2016 - 12:05 | 7077554 insanelysane
insanelysane's picture

Herd stampeding forever - positive!

Herd stampeding off cliff - negative!

Thu, 01/21/2016 - 12:57 | 7077777 JRobby
JRobby's picture

Is there enough ground on this planet for the stampede to continue forever?

Thu, 01/21/2016 - 12:44 | 7077707 BullyBearish
BullyBearish's picture

Executive summary: Buy low, sell high...

Thu, 01/21/2016 - 14:11 | 7078096 slaughterer
slaughterer's picture

Old fashioned Wall Street sharks like Cohen will follow an old timer lile De Mark because he offers a directional call which can net profits quickly.  This latest Kolonavic call is not really directional but a call for a long-term abitrage bet.   Kolonavic has two things against him here: 1) his call cannot be acted on to net quick profits, and 2) he is young and working for JPM, LOL.  Kolonavic still has a risk factor as market strategist.   

Thu, 01/21/2016 - 12:04 | 7077545 XAU XAG
XAU XAG's picture

 relative underperformance of Momentum assets such as USD,

 

 

I think otherwise USD to da moon

 

 

 

Thu, 01/21/2016 - 12:05 | 7077555 savedeposit
savedeposit's picture

I hope it stays there and never returns.

Peace on earth at last

Thu, 01/21/2016 - 12:08 | 7077562 all-priced-in
all-priced-in's picture

I read it but didn't understand it -

 

I need a Cliff Notes version.

 

 

 

 

Thu, 01/21/2016 - 12:12 | 7077570 Winston Churchill
Winston Churchill's picture

You need an English/nerdspeak dictionary.

It eclipses my nerdiness, or he was just stoned.Could be either.

Thu, 01/21/2016 - 14:37 | 7078193 XuscitizenSweden
XuscitizenSweden's picture

Glad to hear that Winston.

Kind'a reminds me of what I heard as a young man in the ´70's while working in the saudi-arabian desert near th Rub Al-Khali/Yemenese Border:

After explaining somethin' to a gigantic young & non-loquacious Texas farmer by the name of Roger, I got a tobacco-chewing rebuttal;

"Why do you use those big 10 dollar words for nickel(5cents) thoughts?"......perhaps not verbatim but pretty damn close.

Thu, 01/21/2016 - 12:16 | 7077589 newworldorder
newworldorder's picture

Here is a secret. The guys running the big banks and most in the White House dont get it either. 

Thu, 01/21/2016 - 12:45 | 7077713 booboo
booboo's picture

Sell Chipotle and buy gold and oil and take that European vacation soon.

Thu, 01/21/2016 - 14:17 | 7078124 dolbiere
dolbiere's picture

i did a few cliff notes but didn't understand them either

Thu, 01/21/2016 - 15:06 | 7078306 Panafrican Funk...
Panafrican Funktron Robot's picture

The stuff that's done really good recently, is gonna do really badly soon.  The stuff that's done really bad recently, is gonna do really good soon.

 

Thu, 01/21/2016 - 19:49 | 7079487 Wild Theories
Wild Theories's picture

nice summary

Thu, 01/21/2016 - 22:23 | 7080082 Vlad the Inhaler
Vlad the Inhaler's picture

He thinks that the big crash in overblown US stocks will be somewhat cushioned by dip buyers picking up beat down EM and commodities on the cheap.  Not sure about this one, the bottom in EM and commodities could drag on for a long time if demand from the rich countries drops off due to recession.  

He also said if the Fed starts printing money again then buy stocks.  Also not sure about this one, we may need a few years break before mom and pop investors will fall for that trick again.

Fri, 01/22/2016 - 03:18 | 7080659 OldPhart
OldPhart's picture

I certainly won't be putting money in the market until the SP is 700 and the DOW is 7000 AND a couple prominent Wall Street Banking presidents are perp walked to jail.

Fri, 01/22/2016 - 07:24 | 7080932 redd_green
redd_green's picture

It may  be a while, OP.

Thu, 01/21/2016 - 12:11 | 7077568 slaughterer
slaughterer's picture

Time for ZH to start tracking the long WTI / short ES trade.

Thu, 01/21/2016 - 13:54 | 7078020 mandalou
mandalou's picture

And thats what the article a few days ago was all about. JP Morgan is looking for this to happen or the complete opposite where they are shorting WTI/Long ES. Would be cool to track it and put Gandalf and his side kicks comments on the charts every day at session close.

Thu, 01/21/2016 - 14:24 | 7078149 dolbiere
dolbiere's picture

goldman needs to pay back the 20 billion to the american taxpayers.

Thu, 01/21/2016 - 12:15 | 7077588 besnook
besnook's picture

they all buy their own bs. the market is controlled by quants with computers. their projections are only as good as the data imputed. analysis derived from computer models can find arbitrage opportunities but is useless for determining value(fangs). it looks to me like the algos have a problem of missing big on both sides, going up and going down. my guess is because of all the fake hft trading, fake data distorts the algos, ironically, in a way the algos can't fully properly adjust to so you get stupid real valuations at both ends.

when people traded the stop was established at a point enough people decided enough was enough. there is no one to do that now so the danger of a cascading, this doesn't make any sense, correction is just as possible as amzn at 1000 times earnings with no earnings in sight.

they really fucked it up this time, ironically in the name of stability.

Thu, 01/21/2016 - 13:03 | 7077800 brada1013567
brada1013567's picture

Average ZH reader viewpoint:

 

Market Up: It's Rigged!

 

Market Down: It's Perfect!

 

 

Thu, 01/21/2016 - 13:37 | 7077949 overmedicatedun...
overmedicatedundersexed's picture

brada, smart boy huh? you work for bls right? UE is just 5% you sure of it ? right.?? hopium is strong with this one.

Fri, 01/22/2016 - 15:49 | 7082683 brada1013567
brada1013567's picture

How  is that working out for ya bud, I think your gonna need some more meds!

God knows you aint getting any sex!

 

A little advice, good traders let the market tell them what to do, bad traders walk in with a belief.

Sun, 01/24/2016 - 11:23 | 7089046 overmedicatedun...
overmedicatedundersexed's picture

brada, good advice, you should do well in crime..leave your morals at the door.

Thu, 01/21/2016 - 14:03 | 7078070 RaceToTheBottom
RaceToTheBottom's picture

Wait, which Market?  The one with QE or the one without it?

Thu, 01/21/2016 - 12:16 | 7077592 Ghost of Porky
Ghost of Porky's picture

Where can I buy one of them "HFT's"?

Thu, 01/21/2016 - 12:21 | 7077615 slaughterer
slaughterer's picture

Apple sells user-friendly smart HFTs at the Apple Store.  Just ask a Genius to take you in the backroom to get one.  

Thu, 01/21/2016 - 12:57 | 7077761 brada1013567
brada1013567's picture

I am waiting for the HFT Pro!

 

 

I hear it is bigger!

Fri, 01/22/2016 - 03:20 | 7080662 OldPhart
OldPhart's picture

I want the HFT Express.

I mean, come on, EXPRESS!!  It's gotta be faster!

Thu, 01/21/2016 - 12:16 | 7077595 DontFollowMyAdv...
DontFollowMyAdviceImaDummy's picture

so in other words, what goes up must come down eventually and history repeats itself AGAIN

Thu, 01/21/2016 - 12:17 | 7077597 22winmag
22winmag's picture

1-20-2017

 

One year away

Thu, 01/21/2016 - 12:23 | 7077619 rejected
rejected's picture

For you "laughing stocks experts" and chart maniacs.

BTFD


 

Thu, 01/21/2016 - 12:24 | 7077620 TradingTroll
TradingTroll's picture

All he said was that this isn't a macro bubble because only some assets are in bubble territory.  So this is a bunch of small asset bubbles which is a corollary  to the meme oft discussed here the past 5yrs+ is that when QE is enacted Noone can predict  where the money flows. This  article is nothing new for ZHers. It is far from an incisive analysis. Then again if we were reading Business  Insider today we would be able to read an article  saying the market will rally for the same reason that two people out of a small group likely have the same birthday. Tomorrow  they will have an article  about a trader whose strategies  are based on the shape of his morning shit.

 

 

 

Thu, 01/21/2016 - 12:23 | 7077622 ebworthen
ebworthen's picture

It's a FED Central Banking bubble.  Rather than investment we have speculation.

"Investors" are trapped in 401K's/IRA's/Pensions and provide a base for the gamblers.

The gamblers rotate in and out of sectors and jigger the daily fluctuations; first-in & first-out in a flash.

The magnet rigged roulette tables, the weighted dice craps tables, the Pavlovian reward cycle slot machines of Wall Street propped by a corrupt .gov leading the defined contribution lemmings through the maze to "retirement" as the real economy sucks wind and lurches toward the tar pits.

Thu, 01/21/2016 - 12:52 | 7077756 LawsofPhysics
LawsofPhysics's picture

Yes, but fun to play with currency you can afford to lose and watch from a pile of productive assets, real capital, real money, and a productive, trustworthy and heavily armed tribe...

But that's just me. Pass the popcorn please...

Thu, 01/21/2016 - 14:35 | 7078184 Not My Real Name
Not My Real Name's picture

The magnet rigged roulette tables, the weighted dice craps tables, the Pavlovian reward cycle slot machines of Wall Street propped by a corrupt .gov leading the defined contribution lemmings through the maze to "retirement" as the real economy sucks wind and lurches toward the tar pits.

Well said. That sums this entire shit show up very nicely.

Thu, 01/21/2016 - 12:26 | 7077633 DirkDiggler11
DirkDiggler11's picture

He said "Macro Momentum Bubbles". More Fed Speak type bullshit. What a verbose bunch of crap.

He could have more easily said " The Fed induced bubble blown up over the past 7 years is getting ready to pop like a mother-fucker, look out below". Of course that would have been a far too easy an explanation, not worthy of his University of Phoenix PHD in Economics.

Thu, 01/21/2016 - 12:33 | 7077662 Winston Churchill
Winston Churchill's picture

He spent good money on that cornflakes box to get that PhD.The gobbledegook class was

extra.

Fri, 01/22/2016 - 07:40 | 7080968 redd_green
redd_green's picture

Uh. dude. I think it was Cracker Jax boxes. Thousands of them.

Thu, 01/21/2016 - 14:47 | 7078237 xrxs
xrxs's picture

Marko's PhD was from NYU in theoretical high-energy physics.  I'm guessing the machinations of the markets are some of the simpler systems he's studied.  I'm a fan of his work. 

Thu, 01/21/2016 - 12:36 | 7077680 PGR88
PGR88's picture

 

 

NOOOO!  Not the macro momentum bubble!

Thu, 01/21/2016 - 12:40 | 7077694 LawsofPhysics
LawsofPhysics's picture

Risk?  LOL!  What is this risk you speak of in a world of "mark to fantasy" accounting and FREE MONEY (QE, ZIRP, NIRP, BAILOUTS, STIMULUS....)

For fuck's sake, words like risk and collateral were outlawed along with gravity a long time ago...

 

 

Thu, 01/21/2016 - 12:43 | 7077705 Atomizer
Atomizer's picture

Goatherder Army Created by United States Of Saudi America – But Who Gives A Fuck.

http://m.youtube.com/watch?v=tIhEFhQLhus

Thu, 01/21/2016 - 12:51 | 7077747 wcvarones
wcvarones's picture

Y ur chart show everything starts +300%?

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