Lucinda Shen 9h 23,590 14 Wall Street WeekLeon Cooperman. The markets went haywire last week, and Wall Street has a hot new theory for why. Numerous investors have pointed to what are called risk parity funds and commodity-trading advisers (CTA) as being partly to blame. Risk parity funds build portfolios around risks: They target a certain exposure to volatility, rather than, say, equities or bonds. That means that when volatility spikes, they sell automatically and indiscriminately. CTAs meanwhile are typically trend followers, meaning they buy when others are buying and sell when others are selling. The latest to point the finger at these things is billionaire investor Leon Cooperman, according to Henry Sender and Robin Wigglesworth at The Financial Times. Cooperman said in a Tuesday letter to investors that events in China and the potential for a US rate hike didn't explain the "magnitude and velocity" of the market decline. Instead he blames systematic and technical investors. The idea that these funds exacerbated the historic volatility of the past two weeks has been gaining traction over the past few days. Bank of America Merrill Lynch said in a note on Thursday that "risk parity funds and CTA's are currently in the spotlight." JPMorgan said in a note last week that most of the selling last week was led by these systematic investors. The note said: "These likely included derivative hedgers and price insensitive investors like CTAs, risk parity funds and other funds that target volatility. These flows exacerbate price action as derivatives hedging causes higher market volatility which puts selling pressure on risk parity portfolio and induces further selling by trend followers. We don't expect a period of prolonged stress as market volatility normalizes and these technical flows subside."
So funds bailed rather than individual retail investors. Not exactly a big difference. Vol went up and investors exited.
Why do they invent new reasons for market volatility? Is a 10% correction something that didn't exist before risk parity funds? People have gotten so used to zero volatility that they need to invent a boogeyman to blame a minor correction on.
Because if they can keep manufacturing "solid" reasons it'll keep mom/pop feeling safe enough to keep their money in it. We can't have them exiting for fear of broken or suspect markets.
ZH also posted this reasoning with some estimates of how much selling and how long it will last. I am still scratchimg my head over the behaviour of US treasuries during that spike in vol.and apparantly some big players were hurt by it as well.one example of broken correlations. A mild bid in 20+ treasuries during a selloff. Unprecedented? Any correct explanations for that?
Probably because financial news sites need to keep their viewership active enough to generate their ad revenue. Check out the margin debt chart, it looks to have peaked in April-May-June of 2015 to an all time high of $507 BILLION. July numbers are out, and margin debt was reduced by approximately $17 billion. It will be interesting to see the August-September numbers and how the margin calls reduced the debt with the recent correction. http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=tables&key=50&category=8
But really, does anyone need a reason other than those who have a job on TV or articles? Before long, making new highs for couple years more to really suck in everyone who were late to the party, people doing same dumb crap in 2007, getting loans to enter stock market or flip houses. This was good buying opportunities, ES closes above 1993 be off to the races.
Exactly for the reason of risk parity funds did fixed income instruments and funds actually sell off rather than being bought during the most recent equity correction. Historical correlations dictate a flight to safety during equity selloffs meaning PMs buy bonds. This time bond funds were not bought in fact bobels and treasuries trade down from before the equity correction because risk parity funds sold fixed income instruments alongside equities. Hence it's not "inventing new reasons" but risk parity fund issues are a valid explanation for the most recent breakdown in correlations.
The selloff in 2008 was different than the selloff in 2009 which was different from the selloff in 2010 and different from the selloff in 2011 and different from the selloff's in aug 2007 and may 2006. If you can figure out what is happening you can figure out what's being dislocated.
Thank you for finding this great read! We never get enough of these strange packages of risk, we need to know as much as we can so we can stay ahead of the public that seems not to care what is happening to their stocks and money.