Wednesday, November 18, 2009

Kass: The Quant Bubble

A must read...... Pflichtlektüre......

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."

Chuck Prince, former chairman and CEO of Citigroup (told to the Financial Times on July 10, 2007).
Kass: The Quant Bubble TSC ( H/T Anti Lemming )

A portion of the sharp rise in several asset classes over the past few months could be the dominance of quant funds that worship at the altar of price momentum (and the self-fulfilling prophecy of the fund flows that follow the price momentum induced by the quants!).

By some estimates, this price-momentum-based quant trading now has doubled in significance since early in the year, to more than two-thirds of the average day's trading.

> I doubt that this figure is correct, but it is verry telling that combined with High Frenquency Trading the "Quants" are the main market force dominating trading...... Doesn´t give me much comfort that the recent gains are "sustainable" ...... Especially after one of the biggest Bear Market Rallies ever on almost non existent Volume ( ! ) ..... Thank god the retail investor this time is smarter than the so called "smart money" ( 13th Straight Week Of Domestic Equity Fund Outflows As Market Rips 11% Over Same Period ) BRAVO ;-)

> Ich bezweifle das die von Kass gennante Zahl in der Tat so hoch ist.... Das aber die Quants zusammen mit dem sonstigen computergetützten Handel ( HFT) der wesentliche "Spieler" ( Investor traue ich mich in diesem Zusammenhang nicht in den Mund zu nehmen.... ) an den momentanen Märkten sind fördert nicht gerade mein Vertrauen in die Nachhaltigkeit in einen nicht "unwesentlicher" Teil der bisher verbuchten Kursgewinne . Nicht verbessert wird das Gesamtbild das der Anstieg praktisch unter minimalen ( ! ) Handelsvolumen stattgefunden hat.. Wenn man jetzt noch bedenkt das wir gerade einer der größten Bear Market Rallies aller Zeiten hinter uns haben sind immer neue Kursziele die man so jeden Tag zu hören bekommt zumindest "mutig"...Glücklicherweise scheint es diesemal so das der "Kleinanleger" sich nicht erneut für das über Jahre erprobte "PUMP & DUMB" begeistern läßt ( 13th Straight Week Of Domestic Equity Fund Outflows As Market Rips 11% Over Same Period ). BRAVO ;-)

Growth of algo trading - Thomson Reuters

Trades initiated by these funds are insensitive to an underemployment rate approaching 18%, signs of an unsteady recovery in housing, the prospects for higher marginal tax rates and how we are going to finance our budget deficit, which hurdles ever higher.

If you don't believe me about the growing quant fund influence, speak to any prominent institutional trader or salesman: They will tell you that their business with plain vanilla institutions is weak and that the quant funds are the ever growing whales of trading.

The pattern is all-too familiar as a new marginal buyer of an asset class dominates the market until they don't.

Here is an anecdote that underscores the changing landscape and is reminiscent of other sectors hiring at tops. (To refresh your memory, this occurred several years ago in private equity and was followed by a sharp cyclical decline in private-equity deals.) At any rate, a subscriber wrote me a telling note recently about his son's friend who attends Wharton and is "a genius in math and game theory." He was just hired by a high-frequency trading firm after being interviewed by 15 similarly talented employees at the firm. He is 20 years old and has been offered approximately $100,000 a year, with a bonus that can add up to an additional $100,000 a quarter! That's far better than even the estimable Goldman Sachs pays!

Keep dancing if you will, but I continue to sit out the melt-up in stocks and the bubble in other asset classes. When investors/traders are arguably overinfluenced by prices (not fundamentals) that dominate the markets, and are all on a similar side, it has the potential to lead to a treacherous and slippery slope, as it did in 2007-08.

Remember, it is some of the same momentum-based quant funds that sold in March 2009 that have been buying over the past few months

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Blogger jmf said...

Stocks are currently priced for a v shaped recovery aka perfection.....

I think the 90 percent ruling out a double dip are betting on more stimulus......

Goldilocks still popular among dund managers, BofAML says FT Alphaville

Global growth expectations for 2010 remain rock-solid with less-than 10% of investors fearing a double-dip. But consensus predicts a small rather than big recovery.

4:28 AM  
Blogger jmf said...

via Rosenberg

The S&P 500 was in a corrective mode and was down more than 6% from the nearby high until forming a bottom heading into November 2, and on that day the index popped seven points and thus far has not looked back. Since that time, there have been 10 up days, 2 flat days and one down day.

So, what was the catalyst for the turnaround back on November 2? It was the ISM index, which bounced more than three points to a three-year high of 56.0 in October.

Now, we acknowledge that the ISM is closely watched by the markets and that strategists construct models that rely heavily on its performance. But in reality, it is only important insofar as it predicts the economy — in this case, the manufacturing sector.

So, it is interesting to see that the ISM surge coincided with a 0.1% decline in manufacturing activity in October, and even more fascinating to see the stock market completely shrug if off.

In other words, this is the hallmark of a highly speculative and liquidity-drive equity market as opposed to fundamentally-driven backdrop.

10:47 AM  
Blogger jmf said...

more from Rosenberg on HERDING, Carry Trade, ROBOTRADING.....

If there is a non-economic risk, it comes down to the U.S. dollar, and Nouriel Roubini is probably onto something in the sense that it has become a huge ‘carry trade’ vehicle for all risky assets.

Historically, there is no correlation at all between the DXY index (the U.S. dollar index) and the S&P 500. In the past eight months, that correlation is 90%.

Ditto for credit spreads — zero correlation from 1995 to 2008, but now it has surged to 90% since April. There was historically a 70% inverse correlation between the U.S. dollar and emerging markets, such as the Brazilian Bovespa, and that correlation has also increased to 90% since the spring.

Even the VIX index, which historically has had no better than a 20% correlation with the U.S. dollar, has now sent that correlation surge to 90%. Amazing.

The inverse correlations between the U.S. dollar and gold and the U.S. dollar and commodities were always strong, but these too have strengthened and now stand at over 90%.

11:00 AM  
Blogger jmf said...

Return Free Risk - A Merger Arb Anecdote
Kid Dynamite

If you're wondering why the stock market (not to mention the government bond market, oil market, gold market, corporate bond market, junk bond market) seems to be rising without logic, it's because of all this liquidity that is MANDATING the devouring of risk assets. In my opinion, this can only end one way... badly.

11:53 AM  
Blogger jmf said...

More on complecency & herding....

Pragmatic Capitalist

My sense is that with it’s rise into public awareness, we are heading into the final throes of USD weakness. For example, when someone like Felix Salmon writing for Reuters does a survey of “How US investors can play the carry trade” that’s got to be a flag. And when phrases like ‘the gimme trade of the century’ are used (Annaly via TPC) in the same breath as describing it’s dynamics – the risk that complacency has set in is pretty darn high.

5:36 AM  
Blogger jmf said...

Anything but .01%
Bill Gross

The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until

Warren Buffet went all-in with the Burlington Northern, but in doing so he admitted it was a 100-year bet with a modest potential return. Still, Warren had to do something with his money; the .01% was eating a hole in his pocket too

6:05 AM  

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