Pre-positioning and Re-positioning

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March 21, 2022
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Much as we like to attribute moves in markets to ‘the news’, more often than not it is the more prosaic elements of portfolio rebalancing and dealer positioning that are the actual driving forces. Post the latest option expiry, this certainly seems to be the case as we explain in a short post.

Last week’s options expiry appeared to have come down on the positive side. Vix, which actually fell to around 27 at the time of the Ukraine invasion, spiked to almost 37 in the first week of March, but has now settled down below 24. We like to think of VIX as the price of Put options, meaning that a lot of people appear to have bought protection at market lows (and put highs). As they say, buy protection when nobody wants it, not when everyone does. Interesting to note that the AAII Bull minus bear index has US retail investors close to lows on Bullish and highs on Bearish for a near record level of net ‘Bearishness’. Historically, this has proved a reasonable contra-indicator. Not entirely, but we would add it in as a supporting factor against the other issues around positioning.

Another important technical feature in our ‘market mechanics’ is dealer Gamma positioning. As we have discussed in the past, ( a more comprehensive discussion can be found in the Market Thinking from last May ) whenever dealers are ‘long gamma’, it means that they act as a counter-balance to other traders, they sell highs and buy lows. However, if they are short Gamma – as has been the case recently – then they do the opposite, rather than acting as a shock absorber, they act as an accelerant, buying highs and selling lows. The chart below (from zero-hedge) suggests that we are near, or indeed have just passed, a “Gamma Flip”, which implies that the recent volatility may now subside as dealers go from short to long gamma. That would be a relief.

The Gamma Flip?

Source Zero Hedge

The final of our three technicalities, or market mechanics, to consider is portfolio re-balancing and the suggestion by JP Morgan that month end rebalancing will involve an estimated flow of $230bn from Bonds to Equities.

All this may sound arcane, but the reality is that while the short term movements in markets are sometimes about sentiment and ‘noise’, they are usually much more a factor of internal market factors around pre-positioning and re-positioning based on risk systems and liquidity rather than external factors or fundamentals.

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Lightning Strikes and Butterfly WIngs

In the internet boom investors chased stocks like Nokia, Ericsson and Cisco to crazy sales multiples that required growth to be not just good, but parabolic to deliver any returns. A small disruption to those expectations led to a profit warning and a crash in the market. AI is the new 'internet' and investors are once again chasing picks and shovels. However, when a market is putting China stocks on less than 1x sales due to 'concerns over China/Taiwan while simultaneously paying 40x sales for a company where half its customers and all its manufacturing is done in the region, there is something of a disconnect in the risk management.

Market Thinking February 2024

The Bond markets have curbed some of their enthusiasm over rate cuts while momentum stays with US tech. Japan and EM ex China continue to behave well, although China continues to behave like a bear market, This has little to do with fundamentals like value or earnings and more to do with perceptions of risk and uncertainty that are driving liquidity flows. However, we would note that the stock market is not the Bellweather of the Economy that it is in the US and that intervention will take place only for stabilisation. They do not believe in the so called Fed put, or the wealth effect.

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