One thing stands out in the latest Fund Managers Survey released this morning from BofA’s Michael Harnett: as he puts it, despite record high corporate bond and stock prices, respondents are the most bearish they have been in 4 years, and are sitting on a “mountain of cash.” To wit: “June FMS big bear signals: cash level of 5.7% (up from 5.5%) = highest since Nov’01; BofAML Risk & Liquidity Index at four-year low; lowest global equity allocation vs. cash/bonds/commodities since Jul’12; most crowded FMS June trade = “long quality”.
Why this paradox? Because according to Harnett, what money managers want, and are holding out for, is a market crash, or as Harnett calls it, “Wanted: policy panic” which would unleash more QE and perhaps, the long-awaited helicopter money.
However, for them to get this long-awaited next installment of printed (or paradropped) money, they need a market crash first. That may be difficult based on positioning, which has seen a broad revulsion toward equities.
As the following chart shows, “relative positioning of Equities vs Everything Else (bonds/cash/commod/real estate) drops to four-year lows (net 1ppt OW).”
And another interesting observation: “The BofAML Risk & Liquidity Index has fallen to 32 from 34 last month. This is the lowest reading in four years. Current risk appetite is 1.6 stdev below average.”
Still, the fund managers may get the crash they want if what JPM’s “quant guru” Marko Kolanovic, warned about a month ago, transpires. Recall:
Given the low levels of volatility and high levels of leverage, the main risk for the market remains a potential volatility shock. Over the past month, low volatility resulted in significantly higher market liquidity. Figure 4 shows the market depth of S&P 500 futures over the past 6 months. One can see that market depth now is almost 3 times higher than during the lows of August or January. This is one of the reasons why the reduction of equity positions of hedge funds and risk parity funds over the past few weeks did not cause much market volatility (i.e. the market easily absorbed it). However, if volatility were to increase, liquidity would dry out quickly. The inset to Figure 4 below shows the relationship between market depth and the VIX. For instance, should the VIX increase above ~20, market liquidity (depth) would like get cut roughly in half. It is this relationship between market volatility and liquidity that leads to increases in ‘volatility of volatility’ (i.e. alternating periods of extremely low and extremely high volatility).
This means that while there is little impetus to sell (or buy) at this moment, which explains the recent complacency in markets, the recent spike in VIX as a result of Brexit risk repricing, may be just the catalyst that forces the illiquid market to snap. Incidentally, if BofA is right, this is precisely what the big money wants (as confirmed by statements by legendary investor billionaires such as Soros, Icahn and Druckenmiller in recent weeks). They may just get it.
