Market Jitters Rise as S&P Drop Triggers Systematic Sell-off Fears

Market Jitters Rise as S&P Drop Triggers Systematic Sell-off Fears 

Just a week ago, it seemed improbable that systematic/CTA sell triggers would be activated soon because the S&P was at a record high and key sell thresholds were far lower. However, following the recent market downturn, investors are becoming concerned that we may soon see CTA liquidations.

Indeed, BNP's market desk has issued a note (available to professional subscribers) warning that this could happen due to Wednesday's market movements. On that day, the S&P dropped 2.3% (the worst day since December 2022), the Nasdaq fell 3.7% (worst since October 2022), and the "Mag Seven" stocks plunged 6% (worst since November 2022). Additionally, AI stocks dropped 5-10%, and the VIX spiked above 18 for the first time since April. The sharp decline also ended the S&P 500's 356-day streak without a 2% drop, the longest streak since 2007.

BNP's models indicate that Wednesday's 2% drop triggered over $25 billion in selling flows in US equities, and without aggressive dip buying, volatility targets and CTA selling could increase significantly. This follows last week's smaller systematic strategy sell-offs, which were offset by large ETF buying flows. However, BNP notes a shift to net selling, with $4 billion leaving SPX-tracking ETFs and equity positioning nearing a maximum long.

Despite these developments, panic selling hasn't set in yet. Over 200 S&P 500 stocks were up on Thursday, with five sectors, led by energy, posting gains. Nonetheless, more correlated moves could lead to increased volatility, especially as continued selling might push dealers to negative gamma, leading to more selling pressure.

Additionally, if the market drops a few more points, it could break the 50-day moving average, triggering further sales. Goldman Sachs' Prime Brokerage also observed that the recent selloff was driven by length reductions by long-only investors rather than further hedge fund de-risking. Gross trading activity increased significantly, particularly shorting in Macro Products, with notable performance in long/short strategies.

Goldman also reported that single stocks were modestly net bought, driven by risk-on flows, with certain sectors seeing significant buying and others selling. Their long/short performance estimates as of July 24 showed mixed results, with fundamental long/short strategies slightly down but systematic long/short strategies up year-to-date.

BNP advises caution in buying into the dip, recommending delta replacement and hedging through SPY put spreads for upcoming expiries to manage risk. Despite this advice, the market saw a strong rebound after the initial selling, indicating that few are heeding these warnings.