It all started with a note by JPM’s Marko Kolanovic last Wednesday, in which he warned that the period of market calm is ending, and volatility was about to surge, which in a reflexive fashion would lead to accelerated selling by quant, systematic and risk-parity funds as a result of near-record leverage. According to Kolanovic while a driver of the recent market stability the “relatively stable macro data and a seasonal decline in trading activity” he explained that “a significant driver of the volatility collapse was derivatives hedging effects, also known as pinning”, as well as the near all-time high leverage for Volatility Targeting and Risk Parity strategies. However, “this is all about to change as a number of important catalysts materialize this month (ECB, BOJ, Fed meetings), seasonals push market volatility higher, and leverage in systematic strategies and option positioning provide fuel for volatility.”

For those who missed his must-read note, which predicted the Friday plunge with uncanny precision, this is what he said:

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So, following Friday’s broad-based deleveraging across all quant, and certainly risk-party funds, the topic of forced selling has dominated sellside research, with BofA releasing a report overnight according to which “multi-asset vol controlled portfolios that use a systematic approach similar to our models may be subject to $12bn in global equity selling pressure in the coming days ahead. Likewise, we estimate about $40bn in global equity selling pressure via CTAs in the near term. Between the two, we could see ~$52bn in near-term selling pressure, half of which may be through US markets. Global equity selling pressure via CTAs could also increase as European and Asian markets had closed before a large portion of the move lower in US equities on Friday.”

Even more interesting is BofA’s comparison of what happened today with the post-Brexit selloff: according to BofA Friday was worse, as the notional volume traded in S&P 500 E-mini futures alone was $516bn. “While the current selling pressure we estimate from quant funds is only ~10% of the volume traded, the key question is if this is just the beginning of more volatility that ultimately puts more selling pressure on the market. In comparison with past shocks, during Brexit our models estimated ~$50bn of selling but only from CTAs and over a ten-day period in August-2015, ~$115bn from CTAs and ~70bn from multiasset risk-parity like funds. Importantly, in a fragile market with low conviction, the risk is that negative price action alone drives further selling.”