What Can Stop This Party?

There’s a pretty strong argument to be made that once vol. spikes sustainably, the biggest risk to markets is what JPMorgan’s Marko Kolanovic is calling “quantitative exuberance.”

That’s a little bit of an eye-roller. Apparently, everyone had the same idea for their year ahead previews. “Let’s do a riff on ‘irrational exuberance.’” Someone was first with “rational exuberance” (Barclays maybe), then Goldman picked it up, so I suppose it was only right that the Street’s most famous quant put his spin on it which, naturally, turned into “quantitative exuberance.”

If you missed it, here’s the quote:

We think that for the next market crisis, irrational exuberance in the ‘tech bubble’ sense is not needed. The reason is the prevalence of quantitative and passive strategies that don’t decide based on emotions, but rather based on measures such as the level of interest rates, volatility, price momentum, or bond-equity correlation. Examples of these strategies include Volatility Targeting, Low Volatility strategies, Trend Following strategies, Risk Parity strategies, Dynamical hedging strategies, Volatility selling strategies, and others. In addition, there are relative value strategies that transmit risk premia compression across asset classes and strategies. With volatility at record lows and central bank balance sheet inflows peaking this year, these strategies currently experience ‘quantitative exuberance’ that poses risk when monetary policies start normalizing in a meaningful way next year.

It’s the same story: what happens if vol. spikes for whatever reason and the rebalance risk in levered and inverse VIX ETPs exacerbates things thus forcing the systematic crowd to deleverage into a falling market? BofAML’s Michael Hartnett seemed to hint at this:

50-year low in stock volatility, 30-year low in bond volatility likely to be followed by flash crash (à la ’87/’94/’98) in H1.