Bigger Stock Swings Put Volatility-Targeting Quants on Notice

The biggest tech slump since the depths of pandemic despair is sending alarms across a $300 billionbreed of quant acutely sensitive to market volatility.

Historical price swings in the S&P 500 Index have jumped in the wake of the plunge in American growth stocks, likely sending automated sell signals to systematic managers who run volatility-targeting strategies.

HSBC Holdings Inc. projects these funds — which buy and sell equities based on changes in realized price swings — could offload $18 billion in U.S. stocks, if the market turbulence continues.

As valuation fears for growth shares sends 20-day volatility to the highest since July, Wall Street strategists warn these traders could now emerge as key sellers after helping to push stocks to records.

“The rather abrupt market moves the last couple of days may have just played a significant role in reducing the extent of further inflows and could in fact trigger outflows,” HSBC global equity strategist Alastair Pinder wrote in a Tuesday note.

When stock swings were muted, volatility-targeting strategies were adding fuel to the equity rally that saw the S&P 500 rise by 60% in the span of six months. But now there are worries that the trend could go in reverse.

Technology giants have tumbled on fears over frothy prices and speculative fever in the options market, chopping 10% off the Nasdaq 100 Index in the span of three days to send realized price swings on the up. Futures for the tech gauge were up 1.6% as of 8:30 a.m. in New York.

These buyers were recently adding fuel to an equity rally that saw the S&P 500 rise by 60% in the span of six months.

“If we were to see this ‘realized vol up’ dynamic sustain moving forward, then volatility-control as a source of prior enormous releveraging ‘buy’ flow can very easily again turn to a mechanical incremental seller,” Nomura Holdings Inc.’s Charlie McElligott wrote in a note last week.

Momentum Whiplash

A similar dynamic threatens to play out among commodity trading advisers, who typically make money by surfing trends in futures markets while monitoring how risky their exposures are with volatility measures.

The recent sell-off has forced them to cut long positions in U.S. shares, with their next positioning threshold for the Nasdaq 100 at 10,820, not far from Tuesday’s close, according to Masanari Takada, a quantitative strategist at Nomura.

On the bright side, volatility-targeting funds hold less than half of what they managed at the start of the year, giving them less heft to move markets dramatically, according to estimates from BNP Paribas SA.

“The space in general appears much less systemically fragile relative to earlier this year,” said Maxwell Grinacoff, a strategist at the French bank.

— With assistance by Justina Lee

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