Why Did The Market Crash? Goldman's Quants Explain

Remember when last week JPM's head quant Marko Kolanovic said there is little risk of the quants puking?

Well, he was wrong.

Here are some thoughts from Goldman's strat team on levels and size of flow from the Passive community which gives an idea as to what drove the accelerating market crash into today's close.

* * *

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
 
The difference between Risk Parity and CTAs:

  1. Risk parity and CTAs (managed futures funds) are not synonymous: Risk parity is a long-only strategy with negatively correlated assets that is sensitive to volatility spikes in the market and positive bond/equity correlation; managed futures funds (CTAs) are long/short strategy funds aimed at capturing trends in the market (in either direction)
  2. The conditions that could lead to forced-model selling impact CTA behavior only such that wide spread selling will generate a downward trend  
  3. Since CTAs look to capture trends in the market, they are likely to apply additional downward pressure on markets if forced-model selling occurs
  4. Additional pressure from CTAs may further exacerbate the sell-off from risk parity funds

 
More details from Goldman's systematic strategist Paul Leyzerovich below…
 
Our baseline expectations are more firmly in sell mode for CTA trend followers

Coming into today, in a flat mkts scenario, we expect >$40bn (or >2x std dev in our work) of global eq sales from this community for the next 1w and >$80bn for the next 1m

  • This is due to negative short-term trend in many markets, medium-trend changes in a few (particularly Europe and Canada) and some VaR de-risking from the higher volatility

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
  • Conversely, if price action improved and bounced higher, the 1w sales would be smaller* and overall 1m activity could be net neutral, representing selling earlier and buying later in the month

The points above are encapsulated in the updated chart below

  • Most of the expected sales represented by the baseline (dark) line are driven by non-US, though US smallcap is contributing with the Russell short-term area breached, and S&P is very close to its latest short-term area of 2,747 in our work**      

Based on the starting point and moves so far, we expect CTA trend has been more relevant to flows than risk parity or insurance vol-control, though those communities are long as well (as are others and non-systematic)

* less than $30bn, depending on the size and speed of the bounce; generally still towards net sales of varying size in most 1w market scenarios
** pursuant to trend, the levels adjust with more time and mkt movements  

 

Comments

NoDebt overbet Mon, 02/05/2018 - 15:29 Permalink

I heard an explanation of risk-parity strategy by somebody (I forget who, but we've all heard his name- a well known investor).  Went something like this:

"Risk-Parity Strategy is like an airbag in your car that always works except when you get in an accident."

In reply to by overbet

Give Me Some Truth gatorengineer Mon, 02/05/2018 - 16:15 Permalink

Gold and silver are the easiest markets to manipulate/contain if needed. On days where the stock market "crashes," I'm sure the manipulators wouldn't want to send a double warning signal by having gold and silver sky-rocket.

This is my working theory and I'm sticking to it. At this writing, gold and silver are now about "unchanged." This after they were monkey-hammered down on Friday. So even if gold and silver do rise in the next few days, they will do so from a lower floor. Makes one wonder if someone knew what was coming.

And why wouldn't gold and silver sky-rocket on a day when the stock market crashes, just after it was announced the government is going to have to borrow $1 trillion in the next 12 months. Also, with the government shut down and debt ceiling crisis upon us.

If we really want to see gold crash, we should start a nuclear war with North Korea.

In reply to by gatorengineer

new game Take-a-Dump Mon, 02/05/2018 - 20:10 Permalink

this tyme it is really really different. i promise.

stockman was right. give him a point. he was adament. another point. plus two for the year. if the rest of what he said comes true, we be very bigly fuked. wage gains-lol. wall street investors lost their asses and that is enough goodly bigly awesomely win for my pin headed brain. thx...

In reply to by Take-a-Dump

Okienomics DownWithYogaPants Mon, 02/05/2018 - 16:46 Permalink

Look, Friday they release the FISA memo and Dow drops 666.

Today Trump appoints an attorney to open a special investigation into FBI/deep state abuses and sedition and here we go, Dow drops 1200.

Leave us the fuck alone to do our business or your legacy will be the next great depression followed by impeachment for the crimes we're about to set you up with.  

GET THE PICTURE?

Sincerely,

The Deep State

In reply to by DownWithYogaPants