By Chris Metli, Executive Director of Morgan Stanley Quant and Derivative Strategies
Looks Like that is Enough for Now
US price action yesterday on the back of the tariff delay was disappointing, and signals that the market may be due for a breather here. Positioning across investor bases remains just about as light as has been all year – there is no change on that front (see Market Still Wants to go Higher from Feb 13th for details). But this week a) pension funds and asset allocators likely have stock to sell (QDS estimates ~$25bn of US equity for sale over month-end) and b) vol target funds are set to slow their pace of buying as leverage creeps higher.
First off, yesterday’s price action stands out on two fronts: 1) the intraday return was weak compared to the overnight gap up, indicating a lack of real money buy-in and was more reminiscent of late 2018 than the first two months of 2019 and 2) there was a notable increase in volatility with the VIX up ~1.35 points despite the SPX rising 12 bps on the day.
The lack of appetite for stocks from active managers runs the risk of being compounded by flow from pensions and asset allocators this week. Given the outperformance of stocks relative to bonds this month, QDS forecasts $25bn of US equity supply from pensions this week and into early next week. While pensions may not fully rebalance back to target weights, directionally the flow is still for sale.
At the same time the pace of vol target buying could slow from here as realized volatility returns to target ranges. QDS forecasts the pace of buying from vol target strategies to fall from nearly $2bn/day over the last few months to ~0.7bn/day over the next two weeks. Vol target funds buying futures have been a meaningful driver of the upward pressure on equities YTD, and this slowing could mean less support going forward.
And more fundamentally, investors are increasingly concerned about the valuation in the market above 2800, which at 17x NTM EPS is the same valuation the S&P 500 traded at for much of 2018 – when growth expectations were higher. While the Fed is giving investors comfort there won’t be much downside in the market, it’s also true that Powell can’t get much more dovish from here, and the risks over each ‘Fed speak’ event are growing more skewed to the downside.