The way Marko Kolanovic sees it, if you’re focused solely on the fundamental catalysts moving markets, you’re only getting part of the story.
Sure, there are brief periods when developments around the trade war or the Federal Reserve‘s latest rate-hike decision dominate proceedings. But on the whole, Kolanovic says there are always technical market forces at play that complement big-picture macro outlook.
He’s speaking specifically about a mystical force known as leverage, which he’s constantly monitoring for directional market signals. The way Kolanovic sees it, leverage — or the lack thereof — can leave the market springloaded for sharp moves in either direction.
“As volatility declines, investors are calibrating the certain amount of risk they’re taking,” Kolanovic explained at a recent meeting with Business Insider. “That process of building out leverage generally means you’re buying assets, as there’s a net-long bias for hedge funds.”
On the flipside, the practice of reducing leverage is normally accompanied by asset sales, which push prices lower.
Leverage is especially notable at the moment because of the impact it’s had on stocks over the past few months.
Following a bout of selling on Christmas Eve that forced them to the brink of a bear market, US equities have seen a torrid recovery, with the S&P 500 soaring more than 22%. Many have attributed this to improved fundamentals, and the idea that many negative forces were shaken out.
But Kolanovic is firmly focused on leverage. He notes that the December meltdown was largely the result of a “very thorough” deleveraging, and says the market’s performance in the months since has also been a function of pent-up risk appetite that’s now uncoiling.
“To the extent we get relevering, it can surprise you in terms of how far it can take the market, regardless of fundamentals,” Kolanovic said. “Declining volatility, very low positioning, and this relevering that’s happened so far this year is largely responsible for market returns. Fundamentals haven’t matched market performance.”
When you consider Kolanovic’s extensive background in physics and math, this quantitative lens for market analysis — one not emphasized to the same degree by his peers — makes total sense. And, more importantly, it’s worked. His unique approach has helped him nail market forecasts.
That’s allowed Kolanovic to achieve the rare distinction of having his research reports move markets while simultaneously demystifying the black box that is quant trading. Ultimately, that prized combination has vaulted him into the elite crust of trusted Wall Street pundits.
Business Insider recently sat down with Kolanovic to get his thoughts on the market as it stands right now — and what it means for the market going forward. The sections below feature direct quotes from the JPMorgan quant guru himself:
What leverage is saying about the market in the near term
“Fundamentals haven’t been overwhelmingly positive over the last two months, yet the market has been going higher. That’s because we started at very, very low exposure and leverage, which is now becoming a tide lifting all assets. And it’s still below average. Yes, this is an unprecedented rally for such a short period of time, but does that mean we have to sell off immediately? No.
“We’re not going to have these types of returns going forward. You’re going to have down days. But the fact that it’s run up so high also doesn’t mean we need to re-test or sell, because leverage is still below average.”
When leverage will start flashing warning signals
“When leverage gets high — 70% to 80% of historical percentile — then maybe you do have cause to be worried. But things generally don’t crash from relatively low positioning.
“It’s not bulletproof. We’re just saying that positioning isn’t that high, and that you may not feel comfortable holding on to the market here. We’re saying there’s a pretty decent chance the market keeps going higher. Not in a straight line, and not at the same pace as we’ve seen, but it can actually go higher. Our price target (3,000) is still quite a ways above current levels.”