(Bloomberg) -- The largest unwind in US equities since the Covid-19 pandemic is over, and now trend-following quant funds are ready to return to the stock market.
Over the past month, so-called systematic funds, which buy stocks based on market signals and volatility moves rather than company fundamentals, have sold the largest dollar-volume of equities in four years, according to Scott Rubner, global markets division managing director and tactical specialist at Goldman Sachs Group Inc.
But now that markets have calmed down, with the Cboe Volatility Index trading around 15 and economic data signaling that the Federal Reserve may be close to sticking a soft landing, systematic funds are expected to buy stocks again.
“Funds are likely to add to the buying pressure more meaningfully should markets stabilize and data prints turn more benign,” Barclays PLC strategists wrote in a note to clients on Monday.
Take volatility control funds, which position themselves in opposition to realized volatility. When the VIX soared last week it triggered a massive selloff by vol control funds, whose equity allocation dropped to roughly 50% from 110%, according to Barclays. Now, with the VIX returned to pre-selloff levels, vol control funds are expected to put those positions back on.
These funds typically sell their positions quickly but take their time when putting them on again. However, the latest jump in volatility came and went so fast that an increase in allocations can happen more rapidly.
“We think that this time around the normalization process can be faster, it’s a matter of weeks rather than months,” Anshul Gupta, head of European Derivatives and Global QIS, said in an interview.
Commodity trading advisers, or CTAs, also could add to the buying pressure, since they almost entirely unwound their equity longs due to growth fears, according to Barclays. For CTAs, the most important factor is the direction of the market and the numerous signals that sends, tracking index moving averages and adjusting their positions when they reach certain thresholds. The more bullish the price trend is, the larger their positions and potentially the tighter the selling trigger gets.
“All they want to see is that the asset is going up,” Gupta said. “And if the market continues to bounce back, they can bring back their long positions quicker.”
Finally, there are risk parity funds, which typically need volatility and correlations to a specific asset class to be as low as possible. As volatility rose and stocks dropped last week, they drastically cut their equity allocations while their bond allocations were likely stable. With the market stabilizing, they’re expected to start buying stocks.
The S&P 500 is up 6.8% since Aug. 5, rising for six straight sessions and erasing the declines that started on Aug. 1. The gains come as speculation rises that the Fed will be able to start cutting interest rates at its September meeting and with earnings growth in the US extending beyond the biggest technology companies.
Of course, the gradual pace of index gains and flows from systematic funds could mean that it takes some time for the buying to show up in market averages. A daily 0.5% move in the S&P 500 over the next month would bring about $59 billion of monthly buying from the funds, according to Nomura Securities International.
But over the longer term, those figures start to add up. For example, three months of a 0.5% daily move in the S&P 500 would bring almost $191 billion of inflows.
“Longer horizon buying flows are huge,” said Charlie McElligott, a cross-asset strategist at Nomura.
(Updates share prices in 11th paragraph. An earlier version of the story was corrected to fix a dollar estimate of fund inflows in second-to-last paragraph.)
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