Potential Stock Market Influx Anticipated

A Wall Street strategist stated Wednesday that a significant amount of money could flow into the stock market in the next month or so. Nomura Securities cross-asset strategist Charlie McElligott said in a report shared with MarketWatch that his model tracking expected fund flows from volatility-control funds indicates these investors could inject over $100 billion into the stock market in the coming month. McElligott described this as the highest predicted value for the model since its activation in 2004. The S&P 500 Index on Wednesday neared its first record closing high since February.

What are Volatility-Control Funds?

Volatility-control funds belong to a branch of systematic funds, which typically use algorithms and pre-set parameters to make decisions, rather than relying on human judgment, and often use leverage and frequently adjust market exposure. The funds tracked by McElligott’s model often use realized volatility (used to measure the actual volatility of a stock over a given period) as a core indicator to determine the size of their allocation in the stock market. Notably, their exposure is not necessarily directly purchasing stocks – many funds primarily trade in the derivatives market, options, and futures contracts.

Drivers Behind the Forecast

He noted that the model's prediction is primarily driven by the impending decline in three-month realized volatility. Realized volatility spiked in late March and early April when the stock market crashed, but as the extreme volatility subsides, risk managers at systematic funds may soon allow them to increase their exposure again. The market’s seemingly restored calm over the past six weeks has also reinforced the perception of a “safe return to the market.”

Interpreting Declining Volatility

A decrease in three-month realized volatility signifies that the market has become less prone to sudden and large price swings. This increased stability suggests that investors have become more confident in the market's outlook, potentially leading to an increased allocation of capital towards equities.

Warnings of Influx Sustainability

McElligott cautioned that this influx may not be sustainable: this type of money lacks stability, and its inflow could spawn a fresh wave of selling. If volatility rears its head again, it could trigger a violent sell-off similar to August – when the unwinding of yen carry trades triggered a global stock market decline. Option traders hedging their exposure could also exacerbate selling pressure.

Model Limitations

McElligott told MarketWatch that the model may underestimate the size of systematic funds. Since most adopters of the strategy are hedge funds, it is difficult to accurately assess the amount of capital that can be allocated. But historically, when the model predicts that systematic traders are likely to buy heavily, the stock market often delivers strong returns in the next 1-2 months, with significant excess returns.

Recent Market Performance

The U.S. stock market has rebounded significantly since April, and Dow Jones Market Data indicates that the S&P 500, if it registers another record high, could become the fastest rebound in history. The Nasdaq 100 Index on Tuesday recorded its first record closing high since February, and tech stocks have been a major driver of the recent market rally.

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Disclaimer: This analysis is for informational purposes only and should not be considered investment advice. Investing in the stock market involves risk, and past performance is not indicative of future results. Always consult with a qualified financial advisor before making any investment decisions.