Morning Note: Perspective

As I type (7:40am pt), we're experiencing one of those infrequent, but, alas, inevitable risk-off days where virtually all correlations move to one... Meaning, asset classes and individual securities that tend to complement each other from a risk standpoint -- i.e., tend to not always move in the same direction, or, better said, not move for the same reasons -- are, so far this morning, moving in the same direction (down), for the same reason(s).

As diversified as we are across asset classes, and across the globe, literally nothing's working so far this morning.

So, what does that mean?  It means today's market action -- triggered by investors reacting to Middle East events -- is what you'd call a "mechanical unwind."  I.e., at least at this juncture, we're not remotely witnessing a fundamentally-driven event in markets.

In a nutshell, today's markets are -- to no small degree -- influenced by computer-driven strategies that have rigid rules when volatility spikes... I.e., they sell automatically, which ultimately results in quite the feedback loop..

Here's one example you blog readers/watchers may be familiar with: 

In past videos I've explained how the options market works... Dealers sell calls to investors when investors are bullish... If the market goes up, the investor wins, the dealer loses... Therefore the dealer protects itself by buying the underlying security (or a derivative of it) alongside the selling of the call... As the market continues to rise, the dealer protects itself by buying more of the underlying, thus exacerbating the upside move.

Now, on the downside (today):  All of those upside hedges the dealers bought to protect themselves get dumped as those calls get dumped, exacerbating the pain... And then of course the put buying comes in; bets by investors that the market will continue falling... Dealers, therefore, having to protect their interests, must short the underlying, or a derivative of it, thus exacerbating the downside move.

But that's not all of these modern market dynamics.

Here's a succinct AI-assisted breakdown into more of the mechanical weeds:

The geopolitical news was the spark. The accelerant is a simultaneous, largely automated unwind across several systematically-managed strategy types:

Vol Control Funds — these strategies target a fixed realized volatility level. When vol spikes, they are forced to reduce equity exposure mechanically, in size, regardless of view. The selling itself raises vol, which triggers further selling. A classic procyclical loop.

Risk Parity — similar dynamic. Leverage plus vol-weighted allocation means equity risk is now "overweight" and must be trimmed across hundreds of billions in AUM.

CTAs / Trend Followers — short-term trend signals have almost certainly flipped negative after a move of this magnitude. Systematic selling from this cohort can persist for days.

Options Dealer Hedging — as calls get sold and puts get bought in a panic, dealers are delta/gamma hedging by shorting equities into the decline. This is a powerful accelerant in the early hours of a move like this.

Forced Liquidation — margin calls, or the anticipation of them, force selling of liquid, appreciated positions across the board. This is why uncorrelated assets — gold, defensives, EM bonds — are also seeing pressure. It's not a fundamental signal; it's a liquidity signal.

So, again, what we're witnessing today is not a coherent indictment of the fundamentals, but rather a button that got pushed, essentially triggering a whole host of systematic reactions.

It doesn't feel good, but of course understanding the dynamics means keeping things in perspective, and acting accordingly.

Stay tuned, and thanks for reading!

Marty