The is exploding higher – what is going on here?
US equities sold off all of a sudden, and the catalyst seems to be the ’’cockroaches’’ that Dimon was referring to in a recent interview.
Plenty of shady and opaque credit being provided through private markets towards unprofitable companies has increased risks in credit markets.
And now a few regional banks are reporting losses as a result of poor lending standards and bad credit exposures.
Regional banks took a big dip yesterday, and the poor sentiment broadened to the entireity of US stock markets.
But there are also technical aspects to consider:
1. Some trouble brewing in the Dispersion Trade
2. Large unwinds in equity L/S hedge fund strategies
The Goldman Sachs VIPs vs most shorted basket tries to replicate the typical long/short hedge fund portfolio: long quality, growth compounding names and short ’’garbage’’ stocks.
That index was down 20%+ (!!!) over the last 30 days until a few days ago.
Proper slaughterhouse in L/S hedge fund land.
As regional banks and other meme stocks are part of the ’’most shorted’’ basket which was squeezing hedge fund books aggressively, the unwind of the short squeeze had large reverberations through markets.
The Dispersion Trade is another technical factor behind yesterday’s move: the trade involves buying single-stock vol and selling vol against it.
An unwind of the Dispersion Trade therefore results in ’’correlation going to one’’ amongst single stocks and a bid to index vol, also known as VIX.
The chart below shows what happened to the VIX curve (today: purple, 1 month ago: orange).
The front-month VIX contracts are exploding higher and the curve has inverted, showing the aggressive bid towards SPX vol which coincides with some unwinds in the Dispersion Trade.
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