J.P. Morgan: After the tech-stock pullback, systematic flows, index rebalances and earnings volatility take center stage in US equities

How much selling pressure remains from systematic funds after the tech-stock decline?

JPMorgan estimates that the target equity leverage of volatility-targeting strategies rose from around the 65th percentile in early October to a peak of the 77th percentile last week, before falling to around the 70th percentile after Friday’s selloff. Leverage remains relatively high, and these strategies could continue selling equities if volatility rises again.
The bank estimates that leveraged ETFs sold more than 35 billion dollars of equity exposure before Friday’s close, over nine-tenths of it tech-related, in the third-largest deleveraging event of the year; some rebalancing demand was offset by dip-buying flows.
Trend-following strategies have already cut S&P 500 and Nasdaq 100 long positions as short-term momentum turned negative. Subsequent flows could go either way: an index rebound could prompt them to add leverage again, while a break below key levels could bring further position cuts.

JPMorgan’s regression of daily ETF returns during the year shows that consumer staples, healthcare and real estate are negatively correlated with the AI theme and are often used as funding sources; bond-proxy sectors such as utilities have been hit by rising yields. The bank also found that the technology sector benefits relatively from higher energy prices.
The US 10-year Treasury yield has fallen nearly 40 basis points from its early-October high, but the bank’s fixed-income strategists believe this was driven mainly by technical factors. Under their fair-value framework, the current yield is approximately 15 basis points too low, with near-term risks tilted slightly to the upside.
Based on its view that rates could rebound and AI stocks could outperform, the bank recommends selling XLP call options expiring in December and buying SPY call options. Its reasoning also includes the following: XLP rose 11% in October, while the S&P 500 fell 1% over the same period, and XLP implied volatility has risen close to a two-year high.
The bank also recommends buying put options on ITB, the homebuilders ETF: US mortgage rates are near a three-year high, and builder confidence fell to a 14-year low in October; nevertheless, homebuilder shares remain up about 11% from their early-October low.

JPMorgan expects high turnover in the Nasdaq 100 annual rebalance. Under its base case, the new constituent weights would lower expected 2027 index dividends by about 4% versus the current portfolio; if Broadcom rises about 10% relative to the index before the 30 November reference date and triggers a weight cap, the decline would widen to about 5%. The final composition depends on market-cap changes before the reference date.
The NYSE Semiconductor Index is consulting on rule changes. If a proposal to remove the aggregate 10% weight cap on American depositary receipts (ADRs) is approved, JPMorgan estimates that ADR weight would rise from about 9.7% to 22.4%. Because these constituents have lower average volatility, index volatility could fall by about 1.5 percentage points after the adjustment, affecting SOXX options and leveraged ETF hedging.

As of the report, about 56% of S&P 500 constituents had reported third-quarter results. Of those, 77% beat earnings expectations by an average of about 2%; the corresponding averages for the prior four quarters were 80% and 8.6%. Companies beating revenue expectations accounted for 68%, with an average beat of 2.1%, also below the prior four-quarter figures of 75% and 2.6%.
Among Russell 1000 companies that had reported results and whose options were relatively liquid, the average absolute share-price move on earnings day was 5.3%, below the 6.1% implied by options at the start of earnings season. However, roughly half of Russell 1000 companies had yet to report, accounting for about 44% of the index’s total market capitalization.

As of the close on 29 October, S&P 500 options implied a midterm election-day move of about 0.7%, below the average actual move of about 1.1% for election events since 2000. Friday’s selloff pushed up near-term volatility, but implied volatility for the election itself changed little.
JPMorgan recommends using First Solar call options to position for the election result: a more favorable congressional seat outcome for Democrats or divided government could reduce the risk of further cuts to solar subsidies. Short interest stands at 11.4% of the stock’s float, and options imply volatility of 4.9% around the election result.