Nomura quants expect US equity futures to remain under significant systematic selling pressure

• Risk-off in equities is spreading, but Nomura says it is a position adjustment by CTAs and other such trend-followers, adding that there is evidence that some other market participants (ultra-short-term traders and global macro hedge funds) are taking the contrarian step of averaging down.


• "It appears that selling has not yet set off the sort of chain reaction in which the withdrawal from long positions by speculative traders leads to an allocation shift among investors with longer-term horizons," Nomura writes, "from this angle at least, many observers may be inclined to see the present selloff as a temporary, mild-to-moderate risk-off scenario similar to the May selloff."


• But Nomura notes that its own measure of stock market sentiment has swiftly deteriorated in a way that looks quite different from what transpired in May. "In particular, an irregular pattern of deterioration in sentiment has taken shape, with stock market sentiment in the US and mainland China turning sharply downward." Nomura explains that at times like this, when sentiment momentarily falls to more than one or two standard deviations below its rolling average, it has often turned out after the fact that the market had been factoring in a slowdown or downshift in fundamentals.


• "The US's imposition of the fourth round of tariffs on Chinese goods may indeed prove to be a game changer," the bank says, "and if sentiment fails to climb back to around risk-neutral, this week (5-9 August), there is good reason to worry that the global selloff in equities will metastasize from the present isolated position adjustments by technically minded investors into a market-wide pricing in of erosion in fundamentals." Nomura's quants also state that the sharp deterioration in our gauge of US stock market sentiment points to rapid deterioration in the balance of supply and demand.


• Nomura says that the sell-off in US stocks seems to be mostly a matter of selling by investors following either trend-following strategies or strategies premised on the assumption of prolonged low volatility. "It appears that stocks are finding support in the form of bargain-hunting by investors following a short-term reversal strategy and investors whose strategies emphasize fundamentals," the bank writes.


• However, Nomura says that the S&P 500 and the NASDAQ 100 have now both fallen below the breakeven lines for the outstanding long positions of trend-following algo investors; "the average cost of CTAs' net buying of futures since June corresponds to an S&P 500 reading of around 2,960 and a NASDAQ 100 reading of around 7,720. The declines in these indices may have thus forced CTAs into loss-cutting mode."


• CTAs' net long position in S&P 500 futures is still only 25% smaller than it was at the 16 July peak, Nomura notes, and CTA's net long position in NASDAQ 100 futures is only 30% smaller than at the 11 July peak. "We therefore expect futures to remain under significant systematic selling pressure."

05 Aug 2019 - 12:48- Research Sheet- Source: Nomura