"Worst Case Scenario" Emerging: Morgan Stanley Warns "Selling Has Shifted"

Confirming JPMorgan's "worst case scenario" that forced de-levering in vol-based strategies would lead to retail ETF outflows and create a vicious cycle downwards, Morgan Stanley's Christopher Metli warns that today’s moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling.

Risk-Parity funds are seeing some of the biggest losses in history...

But, as we previously detailedJPMorgan offered hope that this vicious circle of de-leveraging could be stalled - and had been in the past - by dip-buyers from greater-fool retail inflows.

In the past, just as we have seen this year, these risk-parity-correlation tantrums have been cushioned by equity market inflows, and we note that, in particular, YTD equity ETF flows have surpassed the $100bn mark, a record high pace.

If these equity ETF flows, which JPMorgan believes are largely driven by retail investors, start reversing, not only would the equity market retrench, but the resultant rise in bond-equity correlation would likely induce de-risking by risk parity funds and balanced mutual funds, magnifying the eventual equity market sell-off.

Which could be a problem...

As ETF outflows are surging...

And as Morgan Stanley's Christopher Metli - who previously explained what happens when VIX goes bananas - notes, today’s moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling. 

Systematic supply from vol target strategies is largely out of the way now, while consensus trades are getting hit:  NDX is underperforming SPX, momentum is down 1%, and the Passive Factor is up, indicating actively held names are underperforming names better held by passive funds.

So why now, even though the systematic supply is largely out of the way? 

Well as noted in previous comments, consensus was that this was a dip to be bought and that vol should be sold.  While systematic funds delevered this week, there has been less discretionary supply and end users have bought very little protection. 

This makes the market still fragile to negative shocks – in aggregate less fragile than coming into the week for sure, but still at risk.

The shock today has been higher real rates on expectations of more Fed tightening to come.  After ignoring the original driver of this whole episode earlier in the week, investors have finally returned to the fact that the Fed is going to have to react to a stronger economy.  10y real rates today hit the highest since 2015 indicating tighter financial conditions, and breakevens are down slightly.

In some sense, Metli points out, these ups and downs are a normal reaction to the shock and pain of the Monday selloff, and as noted in previous comments the market usually remains choppy after these events.  A focus on rates and the upcoming CPI report on Tuesday, plus dealers remaining short gamma, likely means the market remains choppy for the next few days.

But Metli does offer some silver-lining hope - just as JPMorgan's Kolanovic did on Tuesday, another -4% SPX move is unlikely given lower systematic supply and less VIX ETP gamma, and the point of max pain is very likely behind us. 

Choppy means +/- 1 to 2% moves for a few days followed by a gradual moderation in volatility as the market digests a more hawkish Fed.

...unless the bond market becomes truly unhinged, he adds.

Finally, Metli notes that right now, the options market does not fully price in a higher volatility environment for longer, and the inverted curve means forward volatility is relatively inexpensive.

June VIX futures are only in the 35th 10-year percentile, while even further out volatility between June and Dec of 2018 is only in the ~10th 10-year percentile – good value versus a VIX that is in the 90th percentile.

Comments

new game A Sentinel Thu, 02/08/2018 - 18:20 Permalink

lower highs and lower lows, until higher highs and higher lows.

we will never see an 08-9 again as the banksters, shysters and corrupt congress and senate learned that letting the free markets do what it is going to do could harm themselves bigly. as in: gone, bankrupt, jobless, loose everything. it will never ever happen(again), hence a china style manipulated market for a long long tyme...

In reply to by A Sentinel

Neighbour lloll Thu, 02/08/2018 - 19:29 Permalink

"Still, no politicians are addressing America's Real problems."

Wait till the rest of the world deals with our problems, ie: Foreign investment morale in USA, unethical economic regulations, currency manipulation and trade wars!

 

Bottom line llol- shut-out of world markets because a new one has taken over.

Swift(ly) will come down, reserve currency status "Kaput".

 

edit: "America First Isolationalism"

 

 

In reply to by lloll

All Risk No Reward Fish Gone Bad Fri, 02/09/2018 - 03:45 Permalink

>>we will never see an 08-9 again as the banksters, shysters and corrupt congress and senate learned that letting the free markets do what it is going to do could harm themselves bigly. as in: gone, bankrupt, jobless, loose everything. it will never ever happen(again), hence a china style manipulated market for a long long tyme...<<

Wrong. A collapse is built into a debt-money based monetary system. It is mathematics - and basic math at that. It isn't rocket science.

What you miss is that the bust is designed to create lots of indebted collateral SO THAT THE MONEY POWER CAN SEIZE THOSE ASSETS WHEN THEY BANKRUPT A GAZILLION PEOPLE IN THE EVENTUAL BUST.

Clued in people used to know this.

“The new law will create inflation whenever the trusts want inflation. From now on depressions will be scientifically created.”
~Congressman Charles A. Lindbergh, after the passage of the Federal Reserve act 1913.

“This Act establishes the most gigantic trust on earth.…When the President signs this Act, the invisible government by the Money Power, proven to exist by the Money Trust Investigation, will be legalized.…The money power overawes the legislative and executive forces of the Nation and of the States. I have seen these forces exerted during the different stages of this bill.…”
~Congressman Charles A. Lindbergh, referring to the act which established the Federal Reserve. Congressional Record, Vol. 51, p. 1446. December 22, 1913.

"The history of the last century shows, as we shall see later, that the advice given to governments by bankers, like the advice they gave to industrialists, was consistently good for bankers, but was often disastrous for governments, businessmen, and the people generally."
Carroll Quigley

"The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks."
~Lord Acton

“When a government is dependent upon bankers for money, they and not the leaders of the government control the situation, since the hand that gives is above the hand that takes. Money has no motherland; financiers are without patriotism and without decency; their sole object is gain.”
~Napoleon Bonaparte

"Let the American people go into their debt-funding schemes and banking systems, and from that hour their boasted independence will be a mere phantom."
~William Pitt, (referring to the inauguration of the first National Bank in the United States under Alexander Hamilton).

How To Be a Crook
https://www.youtube.com/watch?v=2oHbwdNcHbc

Poverty - Debt Is Not a Choice
https://www.youtube.com/watch?v=t7BTTB4tiEU

Renaissance 2.0 The Rise of [Debt-Money Monopolist] Financial Empire
https://www.youtube.com/watch?v=96c2wXcNA7A

Debunking Money
https://www.youtube.com/watch?v=5iBSBVew-3Y

Krugman (and each MIT economist professor - THEY KNOW AND THEY OCCULT!) is a Goebbelsian propagandist as he covers the crimes of wolves with his fake sheep suit and lisp.

Krugman to Lietaer: "Never touch the money system!"
https://www.youtube.com/watch?v=Q6nL9elK0EY

And It's Gone
https://www.youtube.com/watch?v=TGwZVGKG30s

In reply to by Fish Gone Bad

Miggy lloll Thu, 02/08/2018 - 23:22 Permalink

So, the market is re-acting to the potential of higher rates because the economy is starting to get stronger and will continue to do so. This in turns means a more secure job market for those working and not investing.

 

Let it go to 0.

In reply to by lloll

Baron von Bud oddjob Thu, 02/08/2018 - 19:09 Permalink

Fact is, the stock market could go much higher before it goes down. Rising tbond rates won't affect stocks much until they hit 4.5%. At that point the Fed Model kicks in and investors watch the compared earnings yield and bond yield. Lots of room and time here for disciplined money to play the yield gap both ways.

In reply to by oddjob

not dead yet Baron von Bud Thu, 02/08/2018 - 21:15 Permalink

Thing is it's different this time. In the current market the retail investor was pretty much on the sidelines until recently. One big factor in the rise was companies buying back their stock at top dollar. But the biggest and most dangerous buyers were sovereign wealth funds. Awhile back the large Norway wealth fund was 60% in stocks and then went back into the market to buy even more. Japan holds well over half of the Japanese ETF's. Pension funds loaded up too. Lot's of rumors of the FED backstopping the S&P. All of these types of funds are subject to taxpayer panic and if one fund gets pressured to sell the rest will stampede to the sell window to preserve as much as possible. They can blame the retail investor for the current carnage but in the past it was the retail investor, with their buy and hold mentality beat into them while those giving that advice sold and stole their money, eventually steadied the market. The retail aren't there this time so if the big funds panic DOW 1,800 might be a reality.

In reply to by Baron von Bud

new game idontcare Thu, 02/08/2018 - 19:11 Permalink

18k is NOT gone, loose everything, looking for a job. do you not recall 08-09? afer lehman everything was going to the shitter. goldman sacks would be gone. wells, indy, citi, usbank. fuking gone. complete reset. didn't happen did it? down 18k would all ok and fine and doing the usual for these fuks...so we agree? lol...

In reply to by idontcare

hannah new game Thu, 02/08/2018 - 19:40 Permalink

wrong...the banks did die in 08-09. the lid was closing on the casket and the fed reserve stuck their fingers inand stopped it. doesnt mean the banks arent dead. you dont create a quadrillion dollars of fake bad financial shit and jst walk away. the whole fiat system is dead. printing trillion wont save it or bring it back to life.....

In reply to by new game

EddieLomax 101 years and … Fri, 02/09/2018 - 05:36 Permalink

From what I heard retail has been selling the stock market for over a year, this stock market high is purely driven by corporate.

In that it makes sense, once the most profitable trade makes that flip from stocks to bonds everyone has to move at once.  Add in the incentive that the last one to move loses big time and this crash was bound to happen, how low will it go though?

In reply to by 101 years and …