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Kolanovic Says Stocks Rallying on Buybacks, Quant Selling Eases

Kolanovic Says Stocks Rallying on Buybacks, Quant Selling Eases

(Bloomberg) -- Investors should buy stocks because the recent sell-off has prompted a surge in corporate repurchases and the risk of computer-driven selling is dissipating, according to JPMorgan Chase & Co. strategist Marko Kolanovic.

As the S&P 500 slumped 6% over six days through Monday, companies boosted share buybacks to almost $10 billion a day from $3 billion previously, the firm estimates. With stocks sinking and bonds rallying, the big gap in performance spurred a rotation to equities among funds that need to go back to preset asset allocation levels, Kolanovic says.

Kolanovic Says Stocks Rallying on Buybacks, Quant Selling Eases

While the money flows are helping stocks rebound from the biggest loss of the year, investors fretting over an exodus from traders who base their bets on volatility or momentum signals can relax, according to JPMorgan. The equity exposure from these quantitative funds is exaggerated, and some of them are now more inclined to buy than sell, Kolanovic says.

“We see this sell-off as a medium-term buying opportunity,” Kolanovic and his team wrote Thursday in a note to clients. “After a short period of stabilization, markets will likely regain previous highs.”

Kolanovic Says Stocks Rallying on Buybacks, Quant Selling Eases

JPMorgan’s finding on corporate demand echoes that from Goldman Sachs Group Inc. David Kostin, Goldman’s chief U.S. equity strategist, told Bloomberg TV earlier that the firm’s buyback desk saw executions increase “dramatically” Monday when the S&P 500 tumbled 3%.

Stocks started selling off last week after the Federal Reserve played down its easing cycle and the U.S.-China trade war escalated. Some strategists pointed to quants as one of the culprits that may exacerbate the rout. In a note before Monday’s trading, Binky Chadha, chief global strategist at Deutsche Bank AG, said quant traders have raised their equity exposure to one of the highest in the past decade and may dump more than $70 billion of shares in coming weeks should the market turbulence persist.

While acknowledging the fast money’s role in Monday’s carnage, Kolanovic says his firm’s analysis shows these strategists were far from “maximum leverage.” In fact, their exposure sat near the 65th percentile of historic range, he said.

In particular, he notes the risk from commodity trend advisors is “low” as the S&P 500 is stuck between key levels typically watched by the group. CTA traders may start selling when the index falls below its 200-day moving average, a threshold that’s 5% below current levels. At the same time, short-term signals will turn positive with the index poised to reclaim its average levels over the past 50 and 100 days.

“So if anything, CTA flow risk is now skewed to the upside,” the strategists wrote.

Kolanovic Says Stocks Rallying on Buybacks, Quant Selling Eases

Also helping stem equity losses are fund managers who need to rebalance their portfolios when asset allocations deviate from desired levels. Such rebalance is usually done monthly or quarterly, but when stocks and bonds move violently as they just did, funds may opt to adjust right away, according to Kolanovic.

These managers “have built-in triggers to rebalance immediately if the equity-bond spread moves beyond a certain threshold,” he wrote. “Equity drop of 7% and bond rally of 3% (+10% spread) would have triggered many of these rebalances leading to equity inflows.”

JPMorgan’s bullish stance on stocks isn’t unexpected. Last month, the firm’s strategists urged investors to go risk on, citing a concerted effort by global central banks to stimulate the economy. While stocks are still vulnerable to heightened trader anxiety, Kolanovic says he expects President Donald Trump to keep the conflict from escalating.

“The risk to this view is further uncontrolled escalation of trade tensions, which we see as a less likely scenario, given that we’re approaching an election year and a trade-war-induced recession would greatly reduce the probability of the president’s re-election,” he said.

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Brad Olesen at bolesen3@bloomberg.net, Dave Liedtka, Rita Nazareth

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