For Club iNSIDER Traders: Volatility explodes. $230 billion. Potential sell-offs on the horizon

A few weeks ago, after the initial wave of sales from the record highs of the S&P at the beginning of February faded and stocks stabilized in the range of 5500 to 5700 points, we reported that after selling a record $193 billion over two weeks, CTAs, which had previously been 100% net long, turned slightly short, and would no longer be a source of additional sales in a flat market. But not in a market that continues to drop… and certainly not in a market that will lose a surprising 10% in 2 days, as happened at the end of last week.

This means one thing: CTAs will become large sellers again.

Here’s where we stand right now.

1. The total size of long positions from the systematic macro community (CTA/trend-following + risk parity + volatility-controlled products) is estimated at $318 billion, which is not far from the average of long-term minimum and maximum values, and renewed significant sales will shift the long positions from around the 5th to the 2nd or 3rd decile, according to the current situation.

Sales are now receiving more input from volatility-based investors, such as the 1-month realized volatility of the S&P rising to around 33%, and the VIX is at 45 currently.

In a scenario of continuing decline – like what happened on Friday, of course – 1-month sales rise to $190-230 billion globally, as shown in the chart below, and conversely, they decrease over time in a scenario with a sufficiently large rise.

With the movements from Thursday and Friday, short-term, medium-term, and long-term trends are now more negative in the vast majority of global markets, with the CTA baseline increasingly reflecting this, likely resulting in a growing short position, the size of which is determined by the prevailing volatility and binary signals, and how frequently they change.

A key difference from the situation two months ago, when the sale from the CTA community began and it was entirely focused on the US, is that this time the biggest threat comes from stocks outside the US, or as Brian Garrett from Goldman Sachs writes: “There is much more room for CTA sales in global markets outside the US, as the CTA community is still very long” (more details here).

Next week…

Flat market situation: Sellers $57.62 billion (only $2.69 billion outside the US) Rising market situation: Sellers $38.06 billion (only $0.88 billion in the US) Falling market situation: Sellers $68.93 billion (only $5.30 billion outside the US)

Next month…

Flat market situation: Sellers $81.18 billion ($2.95 billion outside the US) Rising market situation: Buyers $25.06 billion ($12.24 billion in the US) Falling market situation: Sellers $116.44 billion ($0.83 billion outside the US)

Looking more closely at the situation in the US, we have already passed all the sales thresholds, and the most recent – the long-term systemic trigger at level 5478 for the S&P, with CTA currently being short $24.7 billion on US stocks.

The positioning of CTAs and the broader systemic positioning of US stocks has been so unwound that it looks like we are nearing the bottom. Reminder, this group are the “trend followers,” so we expect incremental flows in the US equity market.

2. On the other hand, in future contracts for government bonds, CTAs are buying and are expected to make their total global DV01 position net long in the next month, with the US position already being net long, and short positions on other countries outside the US being reduced.

Meanwhile, commodities are expected to see some sales, led by oil and major metals over the next month in the baseline scenario. The performance (NEIXCTAT) is around the lowest levels of the year at -4.5%, although it has not worsened significantly since the second week of March – indicating a rebalance and smoothing of positions that took place – with the large negative performance occurring during the late February – early March period. Liquidity has also worsened again, with the estimated cost of executing a $75 million ES futures order rising to 2.1 basis points, close to yearly highs compared to the year’s average of 1.1 basis points, which is roughly what would be expected with the VIX at its current level (before Friday when it likely worsened further).

Smaller net flows from industrial positions according to the Commitment of Traders (COT) in US stocks during the week before the end of the month and ahead of Independence Day, with institutions selling another $7 billion, bringing long positions down to $271 billion, which is at 21% of the yearly range and 67% historical range on a scale from minimum to maximum.

However, institutions bought almost $30 million DV01 of US government bond futures (2.5 times the standard deviation), which, combined with market movements, brought their position to nearly a record nominal long of about $600 million/basis point.

Meanwhile, uncontrolled traders or “speculators” sold $16 million/basis point of US government bond futures, 1.5 times the standard deviation for the week and the 4th sale in the last 5, bringing their nominal net position to historically low levels. This turned out to be poorly timed, as bonds recently saw a remarkable rise, including during the second half of last week.

4. (S&P) Implied funding continues to become cheaper during this market episode, leading to a tilt in the curve for future funding and providing potential opportunities for lower carrying costs for long-term investors outside the upcoming maturity payment in June.

AXWZ5 – implied funding to December of this year – reached a 1-year low of 50 bps on an annual basis at the end of Friday’s trading, compared to a 1-year average of about 75 bps and a 1-year peak of 115 bps when it was more expensive a few months ago.