Don’t Blame the Quants For Monday’s Stock Rout, Blame the Humans

Wall Street’s favorite whipping-boys want you to know: They’re not responsible for Monday’s bloodbath.

Despite warnings of stretched positioning, there’s little evidence that systematic traders sparked the sharpest equity decline in more than two years, according to Nomura Holdings Inc. While algorithmic funds were probably forced to offload some positions amid the carnage, they likely weren’t “the main culprits,” according to the bank.

Instead, blame asset managers spooked by deteriorating fundamentals, like the coronavirus-induced hit to Friday’s PMI reading. In other words, humans woke up to the growing risk of a pandemic — and panicked.

“We get the impression that a wide range of investors are now factoring in a previously unthinkable scenario,” Masanari Takada, a quantitative strategist at Nomura, wrote in a note on Tuesday.

Through most of last week, traders shrugged off warning signs including an announcement from Apple Inc. that the coronavirus was posing a bigger hit to sales and production than previously expected. A day later, stocks duly rose to another record. But with reports on Monday suggesting authorities were struggling to contain the virus’s spread, caution crept in.

“The main trigger seems to have been human decisions and non-technical factors,” Takada wrote.

Funds that buy and sell based on algorithmic signals are often blamed for exacerbating moves whenever volatility spikes. That’s because commodity trading advisers or CTAs mostly follow market trends, while risk-parity and other volatility-sensitive products adjust positions based on price swings. But not only didn’t they cause Monday’s sell-off, some quants actually made money on it.

JPMorgan Chase & Co.’s models tell a similar story to Nomura’s. While Monday’s action breached trend followers’ short-term momentum levels, their medium-term signals won’t flip red until the S&P 500 Index drops to the 2,900-3,100 range. Their long-term signal is around 2,800, a team led by Bram Kaplan wrote in a Monday note.

“There remains a healthy downside cushion before CTAs would need to de-lever significantly, given the strength of the rally over the past ~4 months,” the strategists wrote.

Monday’s move was likely too swift to register with many programmatic investors who take their cues from longer-term trends, according to Guido Baltussen, co-head of quant allocation at Robeco.

“In general with the virus you have sudden quick reactions. They are typically a bit too quick to be captured by systematic models,” he said.

That’s not to say there’s no more selling to come from programmatic players. JPMorgan estimates volatility-targeting funds’ equity exposure stands at about the 75th percentile, while CTAs’ is around the 85th — levels the strategists describe as “elevated (though not extreme).”

Nathan Thooft, head of global asset allocation at Manulife Asset Management, is on the look-out to see what these funds do before deciding whether to buy into any weakness.

“There is a risk of unwinding by systematic players that could lead to more downside,” said Thooft.

— With assistance by Ksenia Galouchko

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