(Bloomberg) -- The unwinding of risk parity portfolios and other systematic strategies in the wake of the recent bond 'Japantrum' has nearly run its course, according to JPMorgan Chase & Co. strategist Marko Kolanovic.
The bank's Global Head of Quantitative and Derivatives Strategy was likened to the wizard Gandalf last year after similar calls about market flows turned out to be quite prescient. On Thursday, he wrote that "assuming that S&P 500 momentum stays positive (most likely, in our view), and that volatility does not significantly increase further (as important central banks meetings are out of the way)," the recent forced selling from funds following systematic strategies is "mostly completed."
After yields on longer-dated sovereign debt began to surge earlier this month and equity markets sold off in tandem, equity derivatives strategists at Bank of America Merrill Lynch warned that more than $50 billion in selling pressure was in the pipeline. Trend following and volatility targeting strategies that had levered up amid the prior period of market tranquility would now be forced to delever after the S&P 500 fell 2.45 percent on Sept. 9. That plunge constituted a shock that was "likely larger than Brexit for quant funds," according to BofA's team.
After warning of an imminent selloff and spike in volatility on Sept. 6, Kolanovic now thinks the forces that exacerbated that market turmoil have dissipated. Options imbalances that contributed to the selloff in equities on Sept. 9 are no longer putting upward pressure on volatility, he said.
However, that doesn't mean the market is poised to explode higher, as he also predicts limited upside.
"Short term, we favor a continuation of Value, Carry, and Reflation ‘risk-on’ trades that include long emerging market stocks, commodities, and developed market stocks that have cheap valuations," he said. "Short term upside for the whole S&P 500 index is likely not large, given already high valuations (e.g. yield sensitive and low volatility stocks) and uptick in market volatility."