Since institutions must hold more capital and take less risk, there are fewer big players to step in when declines push equities to attractive valuations. The moves are exacerbated by hedge funds employing computerized momentum-based strategies, resulting in corrections that are “faster and deeper,” he said.
“This is not necessarily an unintended impact,” Pinto said. “Regulators wanted to create a system that is safe, not a system where people wouldn’t lose money.”
The new market reality — a topic written about extensively by J.P. Morgan quant Marko Kolanovic — means that big institutional investors are adjusting by holding more cash and moving into or out of positions over longer periods, Pinto said.
“Some asset managers, they see these dips driven by volatility as an opportunity to add risk, but overall, they’re all slightly under invested,” Pinto said. That’s beneficial to markets because “you want dry powder to put to work when you see the market becomes irrational.”
The December losses weren’t confined to equities. Corporate bonds and currencies experienced sudden dislocations that left banks flat-footed. Every major U.S. investment bank reported this month that December’s chaos hurt fourth-quarter performance, pushing fixed-income revenue down by at least 16 percent from the year earlier.
But overall, Pinto said he actually prefers the current market to the pre-financial crisis environment. Instead of continually rising markets, leading ultimately to euphoria and then massive collapse, it’s in a period of rolling corrections that has reined in expectations for corporate profits, he said.
“I don’t dislike what is happening in the markets,” Pinto said. “Whether this is by design or by luck, it’s a better way to navigate the end of the cycle.”