Why The Dow Fell Out Of Bed

Andy’s Notes: All the graphics and fancy schmancy terms aside, the entire jist of this article is that we have a ‘market’ that is trying very very hard to deleverage and unwind 2007-ish stupidity without breaking the whole thing into a million pieces. That’s basically what risk-parity is attempting to examine and analyze. However, with much of the market volume being done via HFT and algorithms (such as the risk-parity model!!!) how reliable is such a signal going to be? Volatility is clearly back. Fasten your seat belts and put your trays in the upright position.

Earlier this morning, Nomura’s Charlie McElligott noted something which in retrospect was quite prophetic: the cross-asset strategist highlighted that his Risk Parity model showed that the market’s most important strategy is in “de-risking” mode as the economic cycle turns sharply:

In a positioning confirmation / “nod” then to this growth- and inflation- slowdown scenario, it is finally worth noting that we see our Risk Parity model having added enormous notional size in global Government Bonds (USTs and JGBs) over the past month, against very large selling of global Equities and Credit.

The implication – and confirmation – judging by today’s market, is that the trade was a long way from finished, looking at the recent risk parity deleveraging in equities…

… offset by buying of gov’t bonds.

But while ongoing (relatively slow) risk parity deleveraging may explain the pressure on the market over the past month, the reason for the sharp waterfall in US stocks just after 12pm ET…

… has to do with another systematic “trader” type in the market: namely the much faster CTAs, or managed futures funds, which do nothing but chase market momentum once it has been established.

As McElligott writes in a follow-up note the Nomura CTA Trend model “is again deleveraging massive notional in long US Equities expressions across SPX, RTY and NDX live.”

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