Hedge fund positioning continues to favour bearish exposures, a configuration that market strategists say could produce sudden and disorderly pullbacks in equities if sell triggers are hit.
In a client note, Goldman Sachs hedge fund sales representative Ioannis Blekos warned that CTA equity sell triggers sit close to current levels. He added that the S&P 500 had already moved through a short-term trigger on Monday morning. Blekos also flagged vulnerabilities in European markets, observing that levels on Germany's DAX were already trading below comparable trigger points.
Blekos characterised U.S. dealer gamma positioning as "very aggressive" and highlighted recent market behaviour as evidence of constrained convexity among dealers. He said that "the volatility reaction on any spot move lower in the last week was panicky given the short dealer convexity." According to his assessment, dealers would need markets to either recover or remain stable at current levels for one to two weeks to rebuild convexity.
The Goldman Sachs note follows similar caution from Bank of America strategists Chintan Kotecha and Nitin Saksena. In commentary last week they cautioned that market declines could "bring stop loss triggers closer," and they put the Euro Stoxx 50 among the indices with the nearest trigger levels. The Bank of America team anticipated short-term selling pressure on equities should weakness continue this week.
Both sets of analysts drew attention to a specific threshold for S&P dealer positioning: they indicated that dealer gamma could flip into negative territory at around 6740 points. That change in positioning is important because negative gamma in dealer books typically intensifies volatility, making spot moves sharper on both the way down and the way up.
The current constellation of heavy hedge fund short exposure, concentrated dealer convexity risks and proximate CTA sell triggers means that market participants are watching levels closely. Should selling accelerate, the interaction of stop-losses, trend-following funds and dealers with limited convexity could magnify moves in equity markets in the near term.