The stock market has been experiencing a turbulent period of volatility and correction, as investors grapple with the uncertainty of the Federal Reserve’s monetary policy, the looming threat of a government shutdown, and the impact of the coronavirus pandemic on the global economy. According to Goldman Sachs Group Inc.’s Scott Rubner, who has studied the flow of funds for two decades, the situation could worsen as options dealers and fast-money traders both turn against the market.
Options dealers in a short gamma position
Rubner explained that market makers, who have the capacity to move millions of shares to hedge their books, are currently in a stance where they have to go with the prevailing equity trend. That is, selling stocks when they go down and vice versa, exacerbating price swings in both directions. This positioning, known as short gamma, has reached the most extreme level since Goldman began tracking the data in 2019.
“This is a no rules market and flows over fundamentals are the drivers of price action into the end of the quarter,” wrote Rubner, a managing director at the bank, in a note. “This dynamic remains negative in the ultra-short term.”
On the flipside, should stocks start to rally again, options dealers would need to chase the market in order to maintain a market-neutral posture. As such, they have the power to fuel market moves in both directions. A 1% shift in the market could translate to $3.3 billion of share buying or selling, according to Goldman’s model.
Trend-chasing systematic funds at risk of unwinding
Rubner also warned that trend-chasing systematic funds, such as commodity trading advisers (CTAs) that surf the momentum of asset prices through long and short bets in the futures market, are at risk of being forced to unwind their equity holdings. By his estimate, CTAs will unload $48 billion of global stocks over the next week even if the benchmarks stand still.
This is because the major stock market indices, such as the S&P 500 and the Dow Jones Industrial Average, have broken below key thresholds, such as the 50-day and 100-day moving averages, that trigger selling signals for these funds.
Rubner’s analysis echoes the view of Morgan Stanley’s trading team, who last week warned about the market’s rising fragility, citing a similar dynamic in positioning among options traders and momentum-chasing quant funds.
Stocks erase earlier losses but remain in correction territory
Stocks erased earlier losses on Wednesday as the S&P 500 recovered from a 0.8% decline to end the session flat. The benchmark index has dropped almost 7% from its 2023 peak in July as the Federal Reserve’s resolve to keep interest rates higher for longer put pressure on stretched valuations. Along the way, the index lost support at 50-day and 100-day averages.
The Dow Jones Industrial Average also closed flat on Wednesday, after falling as much as 0.9% earlier in the day. The blue-chip index is more than 10% below its all-time closing high, entering correction territory.
The Nasdaq Composite, which has been hit hard by the sell-off in growth stocks, managed to gain 0.4% on Wednesday, but remains 22% below its November closing high, putting it in a bear market.
While trading has been orderly during the latest retreat, notable down days are adding up in stark contrast with the summer lull. The S&P 500 has fallen 1% on four separate sessions in the past five weeks. That followed a 47-day streak without a 1% drop through Aug. 1 — the longest run of resilience since January 2020.
