The next market threat to come from speculators slow in exiting U.S. equities: Nomura

Speculators “slow to get out” of long-positions in U.S. stocks pose the next “threat” to the market, Nomura Securities said Monday, the same day U.S. recession fears rocked global stocks sharply lower.

Sharply slowing July U.S. payrolls and the larger-than-expected contraction in the ISM Manufacturing PMI last week ignited worries about a recession. Monday’s stock selloff included the Nasdaq Composite (COMP: IND) pushing further into a correction, and the reversal of the inversion between Treasury 2-year and 10-year yields (USD2Y)(US10Y) for the first time in more than two years.

Commodity trading advisors, or CTAs, have been downsizing their long exposure to U.S. equities, and that process should continue for as long as the S&P 500 (SP500) stays below 5,550, Yoshitaka Suda, a quantitative and macro strategist at Nomura, said in a Monday note.

The S&P 500 (SP500)(IVV)(SPY) was at 5,205 during Monday’s trade. Volatility control funds also appear behind in unwinding long positions in U.S. equities, he said.

“Compared with their positions in other major asset classes, CTAs still have a fairly large aggregate net long position in US equities, making it look increasingly as though they are behind the curve in making their exit,” Suda said and published this chart:

“Rather than welcoming the decline in market interest rates, equity investors seem to have continued pulling the market down steeply out of fear of what lies behind the decline in interest rates—that is, the specter of a slowing economy,” Suda said.

For volatility control funds, there’s “substantial scope” for an equity exposure correction in light of the recent rise in the S&P VIX Index (VIX), he said.

“If they continue trimming their exposure until it becomes commensurate with the VIX’s actual level of over 20, then we are likely to see additional net selling on a scale roughly equivalent to the net selling these funds have already carried between mid-July and now,” he said. The VIX (VIX) during Monday’s trade shot up to +60 reading before coming down to +34.

Here’s a grouping of volatility-based ETFs and ETNs that investors can monitor:

• Short Term Volatility Funds: iPath Series B S&P 500 VIX Short Term Futures ETN (VXX) and the ProShares VIX Short-Term Futures ETF (VIXY).
• Medium Term Volatility Funds: iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ) and ProShares VIX Mid-Term Futures ETF (VIXM).
• Leveraged Volatility Funds: ProShares Ultra VIX Short-Term Futures ETF (UVXY), ProShares Short VIX Short-Term Futures ETF (SVXY), and 2x Long VIX Futures ETF (UVIX).