A Week of 1% Moves on the S&P 500 Could Trigger Forced Selling

It could take just a 1% move in the S&P 500 — up or down — every day for a week for the rally in US stocks to come under significant pressure.

That’s according to data from Nomura cross-asset strategist Charlie McElligott, who said the exposure of volatility-control funds to equities was so high that the risk of a selloff had surged following calm trading in recent months.

These risk-parity funds tend to pile up stocks when they rally during periods of low volatility, forcing them to unwind when trading becomes more choppy — regardless of whether the market is rising or falling. The last time the S&P 500 fluctuated by more than 1% a day for a whole week was at the start of February, the index’s only negative month so far this year.

The “asymmetry” between the potential for selling from these funds versus buying further is “enormous,” McElligott said in an email. A daily move of plus or minus 1% in the S&P 500 for one week would force about $28.8 billion worth of selling, he said. That compares with just about $2.3 billion of buying that would accrue from sideways travel.

To be sure, the US stock market has been relatively calm since the banking turmoil in March, when a string of bankruptcies in regional lenders fanned worries about the health of the global financial system. While the CBOE Volatility Index showed small spikes in May as the US faced an unprecedented debt default, it settled lower fairly quickly in the following weeks. The S&P 500 itself has gained 16% so far this year.

Volatile Moves Have Been Absent Since March