now down 27% versus the S&P since April 1.
Sphere: Related Content
Bookmark this post with:
Showing posts with label quant funds. Show all posts
Showing posts with label quant funds. Show all posts
Friday, May 8, 2009
RIEF/B Underperforms S&P By 8.3% In First Week Of May
Combined with the 18.7% underperformance for the month of April, RenTec's external fund is
now down 27% versus the S&P since April 1.
Sphere: Related Content
now down 27% versus the S&P since April 1.
Sphere: Related Content
Saturday, May 2, 2009
Observations On NYSE Program Trading
Recently, there has been quite a bit of discussion of Goldman Sachs' principal program trading dominance in the NYSE, culminating with none other than Goldman Sachs themselves providing their perspective on the matter, via spokesman Ed Canaday:
The NYSE's most recent classification of the three main market participants is as follows:
Designated Market Makers
Designated Market Makers (DMMs) are at the center of the NYSE market and are the only participants in any market who have true accountability for maintaining a fair and orderly market. DMMs:
Brokers on the NYSE Trading Floor leverage their physical point-of sale-presence with information technologies and algorithmic tools to offer customers the benefits of flexibility, judgment, automation and anonymity with minimal market impact. Trading Floor Brokers:
Supplemental Liquidity Providers (SLPs) are upstairs, electronic, high-volume members incented to add liquidity on the NYSE.
In late November Canaday is quoted as follows:
Another relevant question is just who are the current SLPs? It seems the answer is difficult to pin point. It is known for a fact that Goldman Sachs and Spear, Leeds and Kellogg (owned by GS) are currently definitive SLPs, with Knight Trading and Barclays also presumably becoming SLPs as well, but there has been no confirmation either way, potentially implying that Goldman could have a monopoly in liquidity provisioning. If the program is truly as attractive as GS' spokesman makes it seem, why are other major equity players not clamoring to participate in it? After all, the benefits to SLPs are "obvious."
Following up on that, has there been an extension of the SLP program recently? Zero Hedge has not heard of one. The SLP, which was approved in late October (see above) was supposed to terminate on April 30, this last Thursday: "The proposed pilot program will commence on the date upon which the SEC will approve the New Market Model and will continue for six months thereafter ending on April 30, 2009." If the SLP is now over, should one expect GS's principal volume trading to drop dramatically, if, as Canaday says, the volume is mostly SLP driven? Also, does that mean volatility in the market is about to spike as there are no entities (well, one entity) providing NBB and NBOs?
Indeed, many questions arise when one digs into the nebulous world of NYSE liquidity providers, many more than there are clear cut answers to. Perhaps it is time for Mr. Canaday to address as many of these questions as possible head on. Zero Hedge would be happy to provide him with a forum for clarification.
In the meantime, here are the facts, courtesy of the NYSE's public record keeping system.
The first chart below demonstrates total program trading in the NYSE since mid August, a month before the Lehman bankruptcy. The black line demonstrates total indicated program trading, which absent volatility, has remained relatively stable, averaging roughly 4 billion shares weekly. And while most other NYSE member firms have seen their PT volumes stay relatively flat as well, GS has seen a dramatic ramp up, controlling about 15% of PT in Q3 of 2008 which has risen to almost a quarter of all NYSE PT over the past quarter.
But while total Program Trading includes Principal trading (i.e., trading not on behalf of its clients but for its own benefit; this is the category where SLP would also fall in under NYSE guidelines), as well as Facilitation and Agency trades, the big surprise arises when one looks at a historical analysis of merely Principal trading. The chart below pulls only the Principal trading data for the top 10 NYSE members. And like before, while the total amount of total Principal trading as a portion of NYSE PT has stayed relatively flat, at about half of total PT volumes, Goldman's share has exploded over the past six months: while GS was responsible for around 27% of Principal NYSE stock trading in Q3 and most of Q4, that number has risen to the low 50% range over the past 3 months.
The last two charts demonstrate the divergence of Principal trading as a fraction of total PT by any given broker. It is obvious that while the majority of top NYSE member firms have had Principal trades stay around 40% of their total PT volume, Goldman has seen its share of Principal trading go from 60% all the way into 90%: a vast majority of all its trades are merely for its own benefit (and potentially as an SLP funnel).
And lastly, demonstrating Non-Principal trading indicates, as expected, a trend where GS' client have taken a progressively smaller relative role as part of its total PT, and currently GS Agency volume as a % of Total PT is the lowest of all top NYSE brokers, with total NYSE Agency volume remaining relatively stable.
So what is really going on here? Connecting the dots is difficult with so little freely available information, and the NYSE seems to be keeping mum on disclosing anything above the absolute minimum when it comes to the SLP, and brokers' participation in it.
My interest was piqued by one of the points Canaday brought up: "What the table doesn’t show, but a deeper look at the numbers reveals is that the vast majority of this total is trades by our quantitative trading desk." Maybe Canaday can expand on this a little more, as it is public knowledge that recently the heads of GSAM and Goldman Global Alpha left the company: Ray Iwanowski and Mark Carhart, who ran the quant operation, and Giorgio De Santis who ran research, are no longer at the company. Their departures in themselves are not surprising considering Global Alpha lost over 80% of assets or roughly $10 billion in the course of 2008 (precipitated by the quant shakeout of August 2007). But is there something else going on here? Their departures occurred at the end of March, just as Goldman's Principal % of total NYSE trades had peaked at almost 55%, yet when they departed, this number dropped by a not insignificant 12% to 43%, only to rebound promptly thereafter. Is there more here than meets the eye?
As regular readers of Zero Hedge know, the topic of market liquidity has been a major one over the past 3 weeks, and I have demonstrated that traditional market neutral, high-frequency quants, aka independent liquidity providers have not only suffered significant P&L losses in April, but have deleveraged to a point where their presence in the market is negligible, resulting in dramatic volatility spikes on low volume. Could it be that Goldman is singlehandedly benefitting from being the liquidity provider of last resort, even more so as there are virtually no other participants in the SLP program? And, as is expected, with a liquidity "monopoly", come unprecedented opportunities to take advantage of this, depending on one's view of the market. Of course, Zero Hedge is not suggesting Goldman has done this, but in a world where so little transparency exists into the core workings of the equity market, which most market traders have been clamoring has a "very fishy feel" about it, with Hard To Borrow notices appearing for such major index hedging securities as the SPY and IWR, it is no wonder that explanations are being sought.
In order to provide some much needed visibility, Zero Hedge, as noted above, is hoping Mr. Canaday will approach Zero Hedge and give a more elaborate explanation of what is really happing, and why GS is dominating NYSE program trading, which lately has become a major percentage of total NYSE volume. It is easy to see why market participants could be concerned about this particular breed of opacity. In the meantime, I will continue presenting NYSE program data, as it is everybody's right to be caught up with all the facts. Sphere: Related Content
The NYSE report that Zero Hedge discussed shows Goldman Sachs trading over 1 billion shares in the principal program trading category. What the table doesn’t show, but a deeper look at the numbers reveals is that the vast majority of this total is trades by our quantitative trading desk. This desk is participating in a relatively new NYSE program called Supplemental Liquidity Providers. The NYSE started the program to attract liquidity to the exchange. As an SLP, this the desk makes markets in NYSE stocks. They often do high-frequency trading (which is simply auto-quote market making) where they send out hundreds of “baskets” of stocks at one time. Program trading, as defined by the NYSE report is any strategy that sends out a “basket” of 15+stocks at one time. I am happy to discuss this with you if that description doesn’t make sense.In order to dig deeper into Canaday's statement, Zero Hedge performed a historical analysis of NYSE Program Trading (PT) data (which is public) and came up with some curious observations. But before I get into the results, it makes sense to evaluate the facts behind Goldman's retort and in order to do that, let's first observe just what this Supplemental Liquidity Provider program is.
The NYSE's most recent classification of the three main market participants is as follows:
Designated Market Makers
Designated Market Makers (DMMs) are at the center of the NYSE market and are the only participants in any market who have true accountability for maintaining a fair and orderly market. DMMs:
- Convene both a physical auction convened by DMMs and a completely automated auction that includes algorithmic quotes from DMMs and other market participants;
- Have the obligation to maintain an orderly market in their stocks, quote at the national best bid or offer a specified percentage of the time, and facilitate price discovery at the open, close and in periods of significant imbalances;
- Provide price improvement and match incoming orders based on a pre-programmed Capital Commitment Schedule, which has been added to the NYSE Display Book, minimizing order latency. DMMs and their algorithms do not receive a “look” at incoming orders. This ensures that an intermediary does not see orders first, and that DMMs compete as a market participant;
- Are on parity with quotes from floor brokers and those on the Display Book, encouraging DMM participation and higher market quality.
Brokers on the NYSE Trading Floor leverage their physical point-of sale-presence with information technologies and algorithmic tools to offer customers the benefits of flexibility, judgment, automation and anonymity with minimal market impact. Trading Floor Brokers:
- Have parity with DMMs and the NYSE Display Book, no matter whether the Broker’s order is represented physically or via an algorithm or e-Quote. That is, they can join the first displayed quote on the Book, and split stock with that order.
- Have the ability to route all or part of a customer order to an external algo engine from their handheld order-management device. These algorithms offer Floor Brokers the ability to provide customers with additional execution capabilities in an environment that offers a balanced combination of technology for fast, automated and anonymous order execution; and a physical marketplace for discovering block-sized liquidity and improving prices.
- Can utilize a technology feature called Block Talk to more efficiently locate deep liquidity. Block Talk is designed allow Floor Brokers to broadcast and subscribe to specific stocks they have an interest in, creating an opportunity to trade block-sized liquidity that is not accessible electronically. Since the messages contain no specific order information, customers benefit from a discovery process in a secure environment free of impact, information leakage or intermediation.
- Also have the ability to identify via their hand-held order-management system the last five buyers and sellers in a stock by badge number. They can message a specific member that they are in touch with the contra side. This is valuable information for pricing blocks, as it is about real buyers and sellers, not indications of interest.
- Have a special feature with their reserve orders: when the displayed amount is exhausted, reserve interest replenishes on parity. In contrast, the “upstairs” reserve order functions as it does in an electronic market: replenishing at the back of the queue.
- Are positioned to act on the expanded imbalance and indication information at the open and close of the market. They can participate as agent, or convey insight into the open or close for customers’ decision making.
Supplemental Liquidity Providers (SLPs) are upstairs, electronic, high-volume members incented to add liquidity on the NYSE.
- The pilot SLP program rewards aggressive liquidity suppliers, who complement and add competition to existing quote providers.
- SLPs are obligated to maintain a bid or offer at the National Best Bid or Offer (NBBO) in each assigned security at least 5 percent of the trading day.
- The NYSE pays a financial rebate to the SLP when the SLP posts liquidity in an assigned security that executes against incoming orders. This generates more quoting activity, leading to tighter spreads and greater liquidity at each price level.
- SLPs trade only for their proprietary accounts, not for public customers or on an agency basis.
- An NYSE staff committee assigns each SLP a cross section of NYSE-listed securities. Multiple SLPs may be assigned to each issue.
- A member organization cannot act as a Designated Market Maker and SLP in the same security.
- SLPs have the same publicly available trading information and market data that all other NYSE customers have available to them.
"We’re rolling [the SLP pilot program] out in the 500 most active names where we believe incenting SLPs by compensating them to provide liquidity will supplement all of the other initiatives that we’ve put in place to build the NYSE book."The SLP program was developed in the days after the Lehman collapse when market volatility spiked and major questions about liquidity premia emerged, resulting in program roll out on October 29 of 2008. The full SEC filing describing the minutae of the program is presented below:
In late November Canaday is quoted as follows:
"SLP quoting will provide more liquidity and should make the NYSE more competitive. We have begun to see significant shifts in terms of the frequency with which the NYSE is at the NBBO, and we expect increases in volume and market share to follow."With a mere 500 securities to work with, especially being excluded from being a DMM in SLP names, maybe Canaday can explain the economics to GS' program trading desk from participating in the SLP?
Another relevant question is just who are the current SLPs? It seems the answer is difficult to pin point. It is known for a fact that Goldman Sachs and Spear, Leeds and Kellogg (owned by GS) are currently definitive SLPs, with Knight Trading and Barclays also presumably becoming SLPs as well, but there has been no confirmation either way, potentially implying that Goldman could have a monopoly in liquidity provisioning. If the program is truly as attractive as GS' spokesman makes it seem, why are other major equity players not clamoring to participate in it? After all, the benefits to SLPs are "obvious."
Following up on that, has there been an extension of the SLP program recently? Zero Hedge has not heard of one. The SLP, which was approved in late October (see above) was supposed to terminate on April 30, this last Thursday: "The proposed pilot program will commence on the date upon which the SEC will approve the New Market Model and will continue for six months thereafter ending on April 30, 2009." If the SLP is now over, should one expect GS's principal volume trading to drop dramatically, if, as Canaday says, the volume is mostly SLP driven? Also, does that mean volatility in the market is about to spike as there are no entities (well, one entity) providing NBB and NBOs?
Indeed, many questions arise when one digs into the nebulous world of NYSE liquidity providers, many more than there are clear cut answers to. Perhaps it is time for Mr. Canaday to address as many of these questions as possible head on. Zero Hedge would be happy to provide him with a forum for clarification.
In the meantime, here are the facts, courtesy of the NYSE's public record keeping system.
The first chart below demonstrates total program trading in the NYSE since mid August, a month before the Lehman bankruptcy. The black line demonstrates total indicated program trading, which absent volatility, has remained relatively stable, averaging roughly 4 billion shares weekly. And while most other NYSE member firms have seen their PT volumes stay relatively flat as well, GS has seen a dramatic ramp up, controlling about 15% of PT in Q3 of 2008 which has risen to almost a quarter of all NYSE PT over the past quarter.
But while total Program Trading includes Principal trading (i.e., trading not on behalf of its clients but for its own benefit; this is the category where SLP would also fall in under NYSE guidelines), as well as Facilitation and Agency trades, the big surprise arises when one looks at a historical analysis of merely Principal trading. The chart below pulls only the Principal trading data for the top 10 NYSE members. And like before, while the total amount of total Principal trading as a portion of NYSE PT has stayed relatively flat, at about half of total PT volumes, Goldman's share has exploded over the past six months: while GS was responsible for around 27% of Principal NYSE stock trading in Q3 and most of Q4, that number has risen to the low 50% range over the past 3 months.
The last two charts demonstrate the divergence of Principal trading as a fraction of total PT by any given broker. It is obvious that while the majority of top NYSE member firms have had Principal trades stay around 40% of their total PT volume, Goldman has seen its share of Principal trading go from 60% all the way into 90%: a vast majority of all its trades are merely for its own benefit (and potentially as an SLP funnel).
And lastly, demonstrating Non-Principal trading indicates, as expected, a trend where GS' client have taken a progressively smaller relative role as part of its total PT, and currently GS Agency volume as a % of Total PT is the lowest of all top NYSE brokers, with total NYSE Agency volume remaining relatively stable.
So what is really going on here? Connecting the dots is difficult with so little freely available information, and the NYSE seems to be keeping mum on disclosing anything above the absolute minimum when it comes to the SLP, and brokers' participation in it.
My interest was piqued by one of the points Canaday brought up: "What the table doesn’t show, but a deeper look at the numbers reveals is that the vast majority of this total is trades by our quantitative trading desk." Maybe Canaday can expand on this a little more, as it is public knowledge that recently the heads of GSAM and Goldman Global Alpha left the company: Ray Iwanowski and Mark Carhart, who ran the quant operation, and Giorgio De Santis who ran research, are no longer at the company. Their departures in themselves are not surprising considering Global Alpha lost over 80% of assets or roughly $10 billion in the course of 2008 (precipitated by the quant shakeout of August 2007). But is there something else going on here? Their departures occurred at the end of March, just as Goldman's Principal % of total NYSE trades had peaked at almost 55%, yet when they departed, this number dropped by a not insignificant 12% to 43%, only to rebound promptly thereafter. Is there more here than meets the eye?
As regular readers of Zero Hedge know, the topic of market liquidity has been a major one over the past 3 weeks, and I have demonstrated that traditional market neutral, high-frequency quants, aka independent liquidity providers have not only suffered significant P&L losses in April, but have deleveraged to a point where their presence in the market is negligible, resulting in dramatic volatility spikes on low volume. Could it be that Goldman is singlehandedly benefitting from being the liquidity provider of last resort, even more so as there are virtually no other participants in the SLP program? And, as is expected, with a liquidity "monopoly", come unprecedented opportunities to take advantage of this, depending on one's view of the market. Of course, Zero Hedge is not suggesting Goldman has done this, but in a world where so little transparency exists into the core workings of the equity market, which most market traders have been clamoring has a "very fishy feel" about it, with Hard To Borrow notices appearing for such major index hedging securities as the SPY and IWR, it is no wonder that explanations are being sought.
In order to provide some much needed visibility, Zero Hedge, as noted above, is hoping Mr. Canaday will approach Zero Hedge and give a more elaborate explanation of what is really happing, and why GS is dominating NYSE program trading, which lately has become a major percentage of total NYSE volume. It is easy to see why market participants could be concerned about this particular breed of opacity. In the meantime, I will continue presenting NYSE program data, as it is everybody's right to be caught up with all the facts. Sphere: Related Content
Bookmark this post with:
Thursday, April 30, 2009
Highlighting The Quants' Failed Attempts At Leveraging
As the chart below shows, quant funds attempted to leverage five times in the month of April only to fail every single time. In the meantime the higher trading volume on both the leveraging and deleveraging phase was welcome to brokers like JPM and UBS (and maybe MS?). Net result, the quant performance numbers will be horrendous, as they did not succeed to catch up with their losses as the market went against every single quant factor in existence except for momo high frequency traders who played the simplest of all possible reversion patterns while the market squeezed progressively higher. As ZH reported, the pain at RIEF last week was already likely beyond fixing: this week's update will only make for some low calorie cake icing.
(for new readers, I recommend you read up on the attached labels to get a sense of the problem)
Sphere: Related Content
(for new readers, I recommend you read up on the attached labels to get a sense of the problem)
Sphere: Related Content
Bookmark this post with:
Sunday, April 19, 2009
Bill Miller Correct: "Value" Funds Burying Quants... For Now
Bill Miller is patting himself on the back for "burying" quant funds as this just released Bloomberg article notes: its timely appearance is critical as this is easily the most important theme in the current market dislocation, and thus Zero Hedge will post it in its entirety... Bill, after the worst year in his career, may be careful with the timing of his self-congratulations though...
***
By Alexis Xydias and Lynn Thomasson April 20 (Bloomberg)
Companies with the most debt and lowest returns on assets are turning the biggest six-week rally in stocks since 1938 into a bloodbath for last year’s best-performing trading strategy.
Investors in so-called “quantitative momentum” funds --which speculate that the worst stocks in the past 12 months will continue to decline -- have become this year’s biggest losers after banks and companies that rely on consumer spending surged. Quant momentum managers may have tumbled 27 percent this month in the U.S., the most since at least 1993, while those in Europe may have lost 20 percent in March and 24 percent in April, according to data compiled by JPMorgan Chase & Co.
“Not in a million years would we have expected this gyration to be as vicious and enduring as it has been,” Steven Solmonson, the head of Park Place Capital Ltd., a hedge fund that oversees $150 million, said in an interview from New York.“The quants got whipsawed badly.”
The turnaround battering investors who use mathematical models to pick stocks is making heroes out of last year’s worst-performing money managers. Bill Miller, who lost 55 percent in 2008 running the Legg Mason Value Trust after beating the Standard & Poor’s 500 Index for a record 15 straight years, is topping the measure again. Value investors buy companies that are the cheapest relative to their earnings or assets.
Man Group Plc’s AHL Diversified Futures Ltd., a computerized trading fund, lost 7.1 percent in net asset value since March 9 after surging 25 percent last year. In addition to futures on stock indexes, the fund invests in contracts linked to currencies, bonds, commodities and interest rates.
Skeptical of Rally
This year’s 28 percent rally in the MSCI World Index from its March 9 low is making everyone from Harbinger Capital Partners’s Philip Falcone to NYSE Euronext Chief Executive Officer Duncan Niederauer skeptical the gains will last. Profits at S&P 500 companies dropped six straight quarters through December and are forecast to decline until September, suggesting the stock market will struggle to extend its advance.
The 130 companies in the S&P 500 and Europe’s Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero in the most recently reported period -- more than half of them banks and consumer companies -- rose an average of 82 percent from March 9 through April 17, data compiled by Bloomberg show. That compares with a 29 percent increase for the S&P 500 and a 25 percent jump in the Stoxx 600.
Last week’s 1.5 percent rise in the S&P 500 left it down 3.7 percent this year. The Stoxx 600 gained 4.7 percent, almost erasing its 0.7 percent loss for 2009.
Trend Following
Momentum strategies likely returned 14 percent in the U.S. and 35 percent in Europe in 2008 because industries that tumbled the most in the previous year continued to retreat, according to JPMorgan estimates. These managers sold stocks short, borrowing shares and selling them, hoping to profit by repaying the loans with lower-priced equities. Financial stocks in the U.S. peaked in February 2007, two months before any of the other nine industries in the S&P 500, data compiled by Bloomberg show.
The MSCI World Financials Index slumped 79 percent from its May 7, 2007, peak through March 9, 2009, outpacing the MSCI World Index’s 57 percent drop as losses tied to subprime mortgages climbed toward $1.3 trillion. Since then, the rebound in banks has been almost twice that of the next-best industry.
Momentum strategies failed after government efforts to fix the financial system spurred speculation the first global recession since World War II will end.
$12.8 Trillion Pledged
Banks and other financial institutions in the S&P 500 pared their 2009 losses from as much as 52 percent as lenders from NewYork-based Citigroup Inc. to Bank of America Corp. of Charlotte, North Carolina, said they were profitable at the start of the year. Retailers surged on optimism that the $12.8 trillion pledged by the Federal Reserve and U.S. government will boost the economy and consumer spending.
The net asset value of Man Group’s AHL Diversified fund dropped to $38.71 a share on April 13 from $41.66 on March 9. The MSCI World Index of 23 developed countries rose 26 percent in the same period. London-based Man Group is the world’s largest publicly traded hedge fund manager.
The AHL Diversified Futures fund climbed 25 percent in2008, according to data compiled by Bloomberg. The MSCI World slumped 42 percent last year, the biggest drop since the index was created in 1970.
“Momentum is one factor that does not work in turnarounds,” said Juri Sarbach, a Zurich-based quantitative fund manager who uses the technique and other strategies at Clariden Leu AG, which oversees $81 billion. “When you seek momentum and you have a shift like the one we saw since March, you may find yourself positioned in all the wrong places.”
Worst to First
While momentum investors have suffered in 2009, last year’s worst performers, Miller’s Legg Mason Value Trust and Harry Lange of the Fidelity Magellan Fund, are making comebacks with bets on technology companies.
Both lost more client money than 98 percent of their rivals in 2008 by clinging to or doubling down on shares of financials.
Now, Miller is outperforming 68 percent of his peers with a 1.2 percent gain in 2009 after boosting his stake in Hopkinton, Massachusetts-based EMC Corp. in the fourth quarter. Shares of the world’s biggest maker of storage computers have added 22 percent in 2009.
Lange’s holdings of Corning Inc. contributed to Magellan’s 14 percent jump in March. Corning, New York-based Corning, the largest producer of glass for flat-panel televisions, is up 60 percent this year after saying in March that volumes will exceed its previous estimate.
‘Far From Stabilization’
Maria Rosati, a spokeswoman for Baltimore-based Legg Mason Inc., didn’t return a telephone call seeking a comment. Lange wasn’t available for an interview, said Alexi Maravel, a spokesman for Boston-based Fidelity Investments. Man Group’s Armel Leslie declined to comment.
This year’s gains are making some investors uneasy. Markets “are far from stabilization” because rising unemployment will hold down earnings and consumers have too much debt, Harbinger’s Falcone wrote in a letter to investors on April 15. Harbinger oversees about $7 billion in New York.
The U.S. jobless rate climbed to 8.5 percent in March, the highest in 25 years, and is forecast to rise to 9.5 percent in the fourth quarter, according to the median estimate of 59 economists surveyed by Bloomberg. The Fed’s index of consumer credit outstanding hit a record $2.58 trillion in September and was $2.56 trillion in February.
Profits at S&P 500 companies dropped 38 percent in the first quarter and may slide 32 percent in the second, according to analysts’ estimates compiled by Bloomberg.
66% Beat Estimates
So far, first-quarter incomes have fallen less than forecast. A total of 66 percent of the S&P 500 companies that announced results since earnings season began two weeks ago beat Wall Street projections, the data show.
While credit markets are improving, they haven’t completely recovered. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, is at 0.97 percentage point, down from 1.35 points at the end of2008. It averaged 0.36 points in 2006.
Equity volatility also remains elevated as options dealers resist lowering the price of insuring against losses. The Chicago Board Options Exchange Volatility Index has averaged 44 this year. While down from a record close of 81 in November, that’s still more than twice the average in its 19-year history.
‘Waiting and Watching’
Last month’s surge in equities was accompanied by a jump in trading for Citigroup and Bank of America. The five most active shares on U.S. markets last month accounted for an average of 18 percent of total volume in March and April, compared with 11 percent from June through December of last year, according to data compiled by Bloomberg.
“The majority of institutional investors are waiting and watching, and we need to see a rally with good volume that is more broadly distributed for them to really get back in,” NYSE’s Niederauer said in a telephone interview on April 17. “I’d love to believe that this is the rally that is the precursor of economic recovery in six to nine months, but I’m just trying to keep people from getting too carried away.”
A gauge of non-financial stocks in Europe with characteristics such as an increasing returns on assets, declining debt-to-asset ratios and cash flow that exceeds net income underperformed companies with the opposite criteria by about two-thirds since March 9, data compiled by Bloomberg and New York-based Morgan Stanley show. Morgan Stanley uses a system for analyzing balance sheets developed by Stanford University Professor Joseph Piotroski in 2000.
‘Never Pays’
Companies that Piotroski ranked highest have outperformed the lowest-rated stocks every year but two since 1994, data from New York-based JPMorgan show.
“Buying bad stocks never pays,” said Marco Dion, a London-based quantitative analyst at JPMorgan. Still, “this start of the year will turn out to be quite challenging for the quant community. Most quant managers use some flavor of price momentum in their process and noticing that this factor is failing and in such a significant manner is therefore not good news.”
***
It is gratifying that Bloomberg, which some consider borderline Mainstream Media, is finally catching on to this most critical of topics. We hope Bill Miller enjoys his likely last 30 seconds of fame as he relishes in the "crap" stocks of his "value" fund. Unfortunately, for him he is caught in a cul-de-sac: i) If marginal buyers continue purchasing stocks into oblivion, the implision of the biggest quants will spell the end of the capital markets as we know them, ii) if and when fundamentals finally catch up with the rally before too much damage can be done to the topology of the market, his positive YTD results will swing back down so violently he won't know what hit him.
To point i), Zero Hedge would like to present our readers data we have received compliments of Innovative Quant Solutions, LLC, which performs the tricky task of calculating quant fund performance based on various models. The March data should result in plethora of red warning signs.
We are at a critical crossroads for the future of efficient markets. If the bear market rally persists, Bill Miller and 401(k) holders will be happier temporarily, however the end result would be a broken market. Readers who took offense to the photo of the Challenger explosion earlier, should wake up and realize that we are on the verge of the very same event occurring within the fabric of the free and efficient market system. The threat to the equity markets is not being exaggerated. If the powers that be are intent on rising stock prices one day at a time continually, then even as retail investors enjoy another day of moderate gains, in a few short days/weeks markets will reach a point of no return, and the resultant collapse in confidence in the free market system will force the majority of investors to forever depart from investing in equity markets. The consequences of this would be beyond the scope of even this blog. Sphere: Related Content
***
By Alexis Xydias and Lynn Thomasson April 20 (Bloomberg)
Companies with the most debt and lowest returns on assets are turning the biggest six-week rally in stocks since 1938 into a bloodbath for last year’s best-performing trading strategy.
Investors in so-called “quantitative momentum” funds --which speculate that the worst stocks in the past 12 months will continue to decline -- have become this year’s biggest losers after banks and companies that rely on consumer spending surged. Quant momentum managers may have tumbled 27 percent this month in the U.S., the most since at least 1993, while those in Europe may have lost 20 percent in March and 24 percent in April, according to data compiled by JPMorgan Chase & Co.
“Not in a million years would we have expected this gyration to be as vicious and enduring as it has been,” Steven Solmonson, the head of Park Place Capital Ltd., a hedge fund that oversees $150 million, said in an interview from New York.“The quants got whipsawed badly.”
The turnaround battering investors who use mathematical models to pick stocks is making heroes out of last year’s worst-performing money managers. Bill Miller, who lost 55 percent in 2008 running the Legg Mason Value Trust after beating the Standard & Poor’s 500 Index for a record 15 straight years, is topping the measure again. Value investors buy companies that are the cheapest relative to their earnings or assets.
Man Group Plc’s AHL Diversified Futures Ltd., a computerized trading fund, lost 7.1 percent in net asset value since March 9 after surging 25 percent last year. In addition to futures on stock indexes, the fund invests in contracts linked to currencies, bonds, commodities and interest rates.
Skeptical of Rally
This year’s 28 percent rally in the MSCI World Index from its March 9 low is making everyone from Harbinger Capital Partners’s Philip Falcone to NYSE Euronext Chief Executive Officer Duncan Niederauer skeptical the gains will last. Profits at S&P 500 companies dropped six straight quarters through December and are forecast to decline until September, suggesting the stock market will struggle to extend its advance.
The 130 companies in the S&P 500 and Europe’s Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero in the most recently reported period -- more than half of them banks and consumer companies -- rose an average of 82 percent from March 9 through April 17, data compiled by Bloomberg show. That compares with a 29 percent increase for the S&P 500 and a 25 percent jump in the Stoxx 600.
Last week’s 1.5 percent rise in the S&P 500 left it down 3.7 percent this year. The Stoxx 600 gained 4.7 percent, almost erasing its 0.7 percent loss for 2009.
Trend Following
Momentum strategies likely returned 14 percent in the U.S. and 35 percent in Europe in 2008 because industries that tumbled the most in the previous year continued to retreat, according to JPMorgan estimates. These managers sold stocks short, borrowing shares and selling them, hoping to profit by repaying the loans with lower-priced equities. Financial stocks in the U.S. peaked in February 2007, two months before any of the other nine industries in the S&P 500, data compiled by Bloomberg show.
The MSCI World Financials Index slumped 79 percent from its May 7, 2007, peak through March 9, 2009, outpacing the MSCI World Index’s 57 percent drop as losses tied to subprime mortgages climbed toward $1.3 trillion. Since then, the rebound in banks has been almost twice that of the next-best industry.
Momentum strategies failed after government efforts to fix the financial system spurred speculation the first global recession since World War II will end.
$12.8 Trillion Pledged
Banks and other financial institutions in the S&P 500 pared their 2009 losses from as much as 52 percent as lenders from NewYork-based Citigroup Inc. to Bank of America Corp. of Charlotte, North Carolina, said they were profitable at the start of the year. Retailers surged on optimism that the $12.8 trillion pledged by the Federal Reserve and U.S. government will boost the economy and consumer spending.
The net asset value of Man Group’s AHL Diversified fund dropped to $38.71 a share on April 13 from $41.66 on March 9. The MSCI World Index of 23 developed countries rose 26 percent in the same period. London-based Man Group is the world’s largest publicly traded hedge fund manager.
The AHL Diversified Futures fund climbed 25 percent in2008, according to data compiled by Bloomberg. The MSCI World slumped 42 percent last year, the biggest drop since the index was created in 1970.
“Momentum is one factor that does not work in turnarounds,” said Juri Sarbach, a Zurich-based quantitative fund manager who uses the technique and other strategies at Clariden Leu AG, which oversees $81 billion. “When you seek momentum and you have a shift like the one we saw since March, you may find yourself positioned in all the wrong places.”
Worst to First
While momentum investors have suffered in 2009, last year’s worst performers, Miller’s Legg Mason Value Trust and Harry Lange of the Fidelity Magellan Fund, are making comebacks with bets on technology companies.
Both lost more client money than 98 percent of their rivals in 2008 by clinging to or doubling down on shares of financials.
Now, Miller is outperforming 68 percent of his peers with a 1.2 percent gain in 2009 after boosting his stake in Hopkinton, Massachusetts-based EMC Corp. in the fourth quarter. Shares of the world’s biggest maker of storage computers have added 22 percent in 2009.
Lange’s holdings of Corning Inc. contributed to Magellan’s 14 percent jump in March. Corning, New York-based Corning, the largest producer of glass for flat-panel televisions, is up 60 percent this year after saying in March that volumes will exceed its previous estimate.
‘Far From Stabilization’
Maria Rosati, a spokeswoman for Baltimore-based Legg Mason Inc., didn’t return a telephone call seeking a comment. Lange wasn’t available for an interview, said Alexi Maravel, a spokesman for Boston-based Fidelity Investments. Man Group’s Armel Leslie declined to comment.
This year’s gains are making some investors uneasy. Markets “are far from stabilization” because rising unemployment will hold down earnings and consumers have too much debt, Harbinger’s Falcone wrote in a letter to investors on April 15. Harbinger oversees about $7 billion in New York.
The U.S. jobless rate climbed to 8.5 percent in March, the highest in 25 years, and is forecast to rise to 9.5 percent in the fourth quarter, according to the median estimate of 59 economists surveyed by Bloomberg. The Fed’s index of consumer credit outstanding hit a record $2.58 trillion in September and was $2.56 trillion in February.
Profits at S&P 500 companies dropped 38 percent in the first quarter and may slide 32 percent in the second, according to analysts’ estimates compiled by Bloomberg.
66% Beat Estimates
So far, first-quarter incomes have fallen less than forecast. A total of 66 percent of the S&P 500 companies that announced results since earnings season began two weeks ago beat Wall Street projections, the data show.
While credit markets are improving, they haven’t completely recovered. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, is at 0.97 percentage point, down from 1.35 points at the end of2008. It averaged 0.36 points in 2006.
Equity volatility also remains elevated as options dealers resist lowering the price of insuring against losses. The Chicago Board Options Exchange Volatility Index has averaged 44 this year. While down from a record close of 81 in November, that’s still more than twice the average in its 19-year history.
‘Waiting and Watching’
Last month’s surge in equities was accompanied by a jump in trading for Citigroup and Bank of America. The five most active shares on U.S. markets last month accounted for an average of 18 percent of total volume in March and April, compared with 11 percent from June through December of last year, according to data compiled by Bloomberg.
“The majority of institutional investors are waiting and watching, and we need to see a rally with good volume that is more broadly distributed for them to really get back in,” NYSE’s Niederauer said in a telephone interview on April 17. “I’d love to believe that this is the rally that is the precursor of economic recovery in six to nine months, but I’m just trying to keep people from getting too carried away.”
A gauge of non-financial stocks in Europe with characteristics such as an increasing returns on assets, declining debt-to-asset ratios and cash flow that exceeds net income underperformed companies with the opposite criteria by about two-thirds since March 9, data compiled by Bloomberg and New York-based Morgan Stanley show. Morgan Stanley uses a system for analyzing balance sheets developed by Stanford University Professor Joseph Piotroski in 2000.
‘Never Pays’
Companies that Piotroski ranked highest have outperformed the lowest-rated stocks every year but two since 1994, data from New York-based JPMorgan show.
“Buying bad stocks never pays,” said Marco Dion, a London-based quantitative analyst at JPMorgan. Still, “this start of the year will turn out to be quite challenging for the quant community. Most quant managers use some flavor of price momentum in their process and noticing that this factor is failing and in such a significant manner is therefore not good news.”
***
It is gratifying that Bloomberg, which some consider borderline Mainstream Media, is finally catching on to this most critical of topics. We hope Bill Miller enjoys his likely last 30 seconds of fame as he relishes in the "crap" stocks of his "value" fund. Unfortunately, for him he is caught in a cul-de-sac: i) If marginal buyers continue purchasing stocks into oblivion, the implision of the biggest quants will spell the end of the capital markets as we know them, ii) if and when fundamentals finally catch up with the rally before too much damage can be done to the topology of the market, his positive YTD results will swing back down so violently he won't know what hit him.
To point i), Zero Hedge would like to present our readers data we have received compliments of Innovative Quant Solutions, LLC, which performs the tricky task of calculating quant fund performance based on various models. The March data should result in plethora of red warning signs.
IQS Commentary for March 2009
Summary
The IQS model was down -16.8% over the past 5 weeks, while the sector-neutral model was down 16.9%. [TD: discussion with the appropriate people indicate that April is on par for even worse performance, which is why Zero Hedge has been sounding the clarion call for normality - if market neutral Quants drop 40% in two months, it is truly game over]
·
Balance Sheet and Value added to performance, Improving Financials underperformed slightly, while Sentiment and especially Momentum underperformed.
What Happened?
What does it mean when momentum stops working? The stocks that lost the most over the past few months (dogs of the dow and S&P 500?) outperform the most. (See IQS S&P pdf report for astonishing examples and IQS analysis.)Without an economic catalyst, fundamentals based model would not predict (nor should they) this “dead cat” bounce. Are we witnessing a sustainable rally for these stocks? It’s possible, but not very likely. Some of these companies are financials, and the “risk” to this industry changes daily, but remains high. However, some of these companies are not financials, and investors are buying up these low priced stocks with the hope that the economic turnaround has started and will continue to improve. With reporting season upon us, guidance will help determine the direction and magnitude of the market during this period. If financials show an improvement, the market may take off. If most
companies continue to post low or negative earnings without a clear picture of a turnaround, the market may retract.
Weights
The IQS dynamic weighting system made small changes this month to the weights. With the market and economic conditions still weak.
Some weight was added to Improving Financials (mid), while a little weight reduced Momentum (mid), from Value (low), Balance Sheet (mid).
What is the IQS Model telling us about Sectors? No significant changes from last month.
Best – Aerospace, Retail, Medical, Utilities, Consumer Staples
Middle –Business Services, Oils/Energy, Industrial Parts, Transportation, Technology, Basic Materials
Worst – Autos, Finance, Construction, Conglomerates, Consumer Discretionary
We are at a critical crossroads for the future of efficient markets. If the bear market rally persists, Bill Miller and 401(k) holders will be happier temporarily, however the end result would be a broken market. Readers who took offense to the photo of the Challenger explosion earlier, should wake up and realize that we are on the verge of the very same event occurring within the fabric of the free and efficient market system. The threat to the equity markets is not being exaggerated. If the powers that be are intent on rising stock prices one day at a time continually, then even as retail investors enjoy another day of moderate gains, in a few short days/weeks markets will reach a point of no return, and the resultant collapse in confidence in the free market system will force the majority of investors to forever depart from investing in equity markets. The consequences of this would be beyond the scope of even this blog. Sphere: Related Content
Bookmark this post with:
Quantitative Strategies During Recessions Examined
As the recent quant thread on Zero Hedge has stirred a firestorm of interest into this arcane field of finance, I present an interesting academic paper courtesy of Dr. Vinay Nair who previously worked as a PM and Research Director with none other than Vikram Pandit at Old Lane, and author of Investing for Change. Nair looks at the performance of two primary quant strategies during recessionary times: Momentum (Up Minus Down as defined by Fama French) and Value (High Minus Low) to determine how quants fare in odd times such as these. As Mr. Nair shares with Zero Hedge:
Momentum (as defined) is one of the most popular (and crowded) strategies in the quantitative equity market neutral space, and, as the research note shows, loses out in bear market rallies or recovery rallies. Combine this fact with the increased importance of quant trading in markets and I would expect to see sharper rallies than in previous cycles (Market goes up > momentum suffers > quant guys liquidate momentum > market goes up further).
This is yet another datapoint indicating how technically self sustaining the market may get until there is terminal pain for key liquidity providers as they increasing shift to avoid orderly market strategies and programs.
In his report, Nair states:
In order to generate returns to value and momentum factors, we rely on the most widely used proxies, first generated by Ken French and Eugene Fama. The Fama‐French version of Momentum is known as Up Minus Down (UMD). The Fama‐French version of the Value strategy is called High Minus Low (HML).3 For purposes of a benchmark, we also include the strategy of investing in the market and selling Treasury bills (MKT). Ken French maintains a data library with returns to their versions of each strategy from January 1927 till February 2009.
However, when we consider performance during recessions, our conclusion shifts. Not surprisingly, investing in the market is a painful experience during recessions with an average return of ‐8.73% and volatility of 28%. Value performs similarly ‐ with returns falling to 1.51% and markedly increased volatility, the IR becomes an unremarkable 0.09. Momentum, on the other hand, holds up rather well with similar returns in expansionary and recessionary periods. The strategy does become volatile, thus causing the IR to drop but remain at a healthy 0.36.
All of the negative market exposure of momentum is concentrated during recessions, with both the up and down market exposures becoming ‐0.32. Outside of recessions, the strategy has no real exposure to rising markets and a positive exposure of 0.26 to falling markets. This suggests that much of the diversification benefit of investing in Momentum occurs during recessions. In stark contrast, Value’s low beta behavior disappears during recessions. In recessions, Value’s beta to falling markets becomes 0.14, precisely when one would not want it.
The current recession has seen these strategies behave as expected. Figure 1 plots an investment made at the end of 11/2007, right before the NBER start date for the current recession. The overall market has been a terrible investment, particularly since the beginning of 10/2008. Value returns were relatively stable and did well prior to 10/2008, rising 9% in three months. However, as the market began substantial declines in October, the strategy began to move more closely with the market and lost 25% over the next five months. In contrast, Momentum has performed relatively well, with annualized returns of 22% at 20% volatility throughout the recession.
However, we also haven’t seen significant bear market rallies or recoveries in this sample (the data from Ken French does not yet include March 2009). One would expect momentum to give back some gains during these rallies and during the period of recovery in equity markets.
Bookmark this post with:
Sunday, April 12, 2009
Quantology Revisited: The Negative Convexity Implications Of Delta-Hedging
I thank readers who provided tremendous insights on the market illiquidity post. However, one point that nobody mentioned, which may very well be at the heart of the problem, has to do with the issue of negative convexity from a delta-hedging perspective. Zero Hedge had previously discussed the implications of this very peculiar phenomenon two months ago in the context of CDO trend chasing in the CDS market and how negative convexity (especially in illiquid markets) leads to explosive and self-fulfilling rallies on either side.
I thank an anonymous reader for presenting the missing piece of the puzzle, and taking the convexity argument one step further from merely structured finance to the entire market. I welcome responses and apologize for the thematic wonkiness, however there is only so much simplification that can be presented. But a simplified attempt: we have crossed into territory where the negative convexity consequences of delta hedging will keep on pushing the market in a straight line in whatever direction it is moving until we see a violent reversal and the delta hedge breaks due to lack of vol to "feed it", which will be, in the parlance of our times, the market's epic fail.
I thank an anonymous reader for presenting the missing piece of the puzzle, and taking the convexity argument one step further from merely structured finance to the entire market. I welcome responses and apologize for the thematic wonkiness, however there is only so much simplification that can be presented. But a simplified attempt: we have crossed into territory where the negative convexity consequences of delta hedging will keep on pushing the market in a straight line in whatever direction it is moving until we see a violent reversal and the delta hedge breaks due to lack of vol to "feed it", which will be, in the parlance of our times, the market's epic fail.
What is good for GS is good for US... Young analysts, just starting in GS the London office not too long ago were told that delta hedging of equity derivatives books can account for up to 30% of market volumes. TD's data clearly demonstrates that vanilla, slow money are being swamped by quant props.Sphere: Related Content
Delta hedging of GS, DB, BNP and other dealers listed/OTC equity derivatives books could be what others construe as a 'sinister plot' to goose up US markets. OTC derivatives are many times bigger than listed and often hedged on listed markets. Clearly many books got caught short upside gamma and that will force them to buy indices and individual names as market goes up. The higher the market goes, the more they need to buy. Markets are getting too small for all the large players to operate efficiently. All of them need to get smaller or some will die.
TD's ideas and data can be taken further and what started as low level liquidity provision issues expanded into market neutral quant problems and spilled in derivatives creating a self-feeding process. More quant problems leads to further short covering, higher markets, further delta hedging, more vanilla, slow money getting sucked in and ever sunnier CNBC commentators and Time magazine contributors. Until, as TD puts it, it doesn't.
Bookmark this post with:
Friday, April 10, 2009
The Incredibly Shrinking Market Liquidity, Or The Upcoming Black Swan Of Black Swans
"Anyone who is doing anything sensible right now is either losing money or is out of the market entirely." These are the words of a quant trader, who is seeing something scary in the capital markets. Scary enough to merit a warning that we could be on the verge of another October 87, August 2007, or January 2008.
Let's back up. I recently posted a chart which tracks equity market neutral strategies: in essence a cross section of quant funds for which there is public performance tracking. The chart is presented below.
There is not much publicly available data to follow what goes on in the mystery shrouded quant world. However, another chart that tracks the market neutral performance is the HSKAX, or the Highbridge Statistical Market Neutral Fund, presented below. As one can see we have crossed into major statistically deviant territory, likely approaching a level that is 6 standard deviations away from the recent norms.
What do these charts tell us? In essence, that there is a high likelihood of substantial market dislocations based on previous comparable situations. More on this in a second.
Why quant funds? Or rather, what is so special about quant funds? The proper way to approach the question is to think of the market as an ecosystem of liquidity providers, who, based on the frequency of their trades, generate a cushioning to the open market trading mechanism. It is a fact that the vast majority of transactions in the market are not customer driven buy/sell orders, but are in fact high frequency, small block trades that constantly cross between a select few of these same quant funds and program traders.
This is a market in which the big players are Renaissance Technologies Medallion, Goldman Sachs and GETCO. Whereas the first two are household names, the last is an entity known primarily to quant market participants. Curiously, the Philosophy section in GETCO's website exactly captures the critical role that quant funds play in an "efficient" market.
In order to maintain market efficiency, the ecosystem has to be balanced: liquidity disruptions at any one level could and will lead to unexpected market aberrations, such as exorbitant bid/ask margins, inability to unwind large block positions, and last but not least, explosive volatility: in essence a recreation of the market conditions approximating the days of August 2007, the days post the Lehman collapse, the first November market low, the irrational exuberance of the post New Year rally, and the 666 market lows.
The above tracking charts indicate that something is very off with the "slow", "moderate" and "fast" liquidity providers, indicating that liquidity deleveraging is approaching (if not already is at) critical levels, as the vast majority of quants are either sitting on the sidelines, or are merely playing hot potato with each other (more on this also in a second). What this means is that marginal market participants, such as mutual and pension funds, and retail investors who are really just beneficiaries of the liquidity efficiency provided them by the higher-ups in the liquidity chain, are about to get a very rude awakening.
Also, it needs to be pointed out that the very top tier of the ecosystem is shrouded in secrecy: conclusions about its state can only be implied based on observable metrics from the HSKAX and HFRXEMN. It is safe to say that any conclusion drawn based upon observing these two indices are likely not too far off the mark.
Skeptics at this point will claim that it is impossible that quant and program trading has such as vast share of trading. The facts, however, indicate that not only is program trading a material component of daily volumes, it is in fact growing at an alarming pace. The following most recent weekly data from the New York Stock Exchange puts things into perspective:
According to the NYSE, last week program trading was 8% higher than the 52 week average, which on almost 4 billion shares is a material increase. It is probably safe to say that the 1 billion in program trades last week does not account for significant additional low- to high-frequency trades originated at non NYSE members, implying the real number for the overall market is likely even higher. Some more program trading statistics: principal trading is running 21% above 52 week average, agency trading is 11% below average, while NYSE weekly volume is running about 9% below 52 wk average.
A very interesting data point, also provided by the NYSE, implicates none other than administration darling Goldman Sachs in yet another potentially troubling development. The chart below demonstrates the program trading broken down by the top 15 most active NYSE member firms. I bring your attention to the total, principal, customer facilitation and agency columns.
Key to note here is that Goldman's program trading principal to agency+customer facilitation ratio is a staggering 5x, which is multiples higher than both the second most active program trader and the average ratio of the NYSE, both at or below 1x. The implication is that Goldman Sachs, due to its preeminent position not only as one of the world's largest broker/dealers (pardon, Bank Holding Companies), but also as being on the top of the high-frequency trading/liquidity provision "food chain", trades much more often for its own (principal) benefit, likely in tandem with the other top dogs on the list: RenTec, Highbridge (JP Morgan), and GETCO. In this light, the program trading spike over the past week could be perceived as much more sinister. For conspiracy lovers, long searching for any circumstantial evidence to catch the mysterious "plunge protection team" in action, you should look no further than this.
Following on the circumstantial evidence track, as Zero Hedge pointed out previously, over the past month, the Volume Weighted Average Price of the SPY index indicates that the bulk of the upswing has been done through low volume buying on the margin and from overnight gaps in afterhours market trading. The VWAP of the SPY through yesterday indicated that the real price of the S&P 500 would be roughly 60 points lower, or about 782, if the low volume marginal transactions had been netted out. And yet the market keeps on rising. This is an additional data point demonstrating that the equity market has reached a point where the transactions on the margin are all that matter as the core volume/liquidity providers slowly disappear one by one through ongoing deleveraging.
Unfortunately for them, this is not a sustainable condition.
As more and more quants focus on trading exclusively with themselves, and the slow and vanilla money piggy backs to low-vol market swings, the aberrations become self-fulfilling. What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme. As the overall market volume is substantially lower now than it has been in the recent past, this strategy has in fact been working and will likely continue to do so... until it fails and we witness a repeat of the August 2007 quant failure events... at which point the market, just like Madoff, will become the emperor revealing its utter lack of clothing.
So what happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible: large swings on low volume, massive bid-offer spreads, huge trading costs, inability to clear and numerous failed trades. When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility. Furthermore, high convexity names such as double and triple negative ETFs, which are massively disbalanced with regard to underlying values after recent trading patterns, will see shifts which will make the November SRS jump to $250 seem like child's play.
For readers curious about just how relevant liquidity is in the current market, I recommend another recent post that discusses DE Shaw's opinion on the infamous basis trade, in which their conclusion was that establishing a basis trade, which is effectively the equivalent of selling a put option on market liquidity, ended up in massive financial carnage as the market rolled from one side of the trade to another. Is it possible that what the basis trade was for credit markets (most notably Citadel, Merrill and Boaz Weinstein), so the quant unwind will be to equity markets?
So when will all this occur? The quant trader I spoke to would not commit himself to any specific time frame but noted that a date as early as next Monday could be a veritable D-day. His advice on a list of possible harbingers: continued deleveraging in quant funds as per the charts noted above, significant pre-market volatility swings as quants rebalance their end of day positions, increasing principal program trading by Goldman Sachs on decreasing relative overall trading volumes, ongoing index VWAP dislocations. One thing is for certain: the longer the divergence between real volume trading/liquidity and absolute market changes persists, the more memorable the ensuing market liquidity event will be. At the end of the day, despite the pronouncements by the administration and more and more sell-side analysts that the market is merely chasing the rebound in fundamentals in what has all of a sudden become a V-shaped recovery, the "rally" could simply be explained by technical factor driven capital-liquidity aberrations, which will continue at most for mere weeks if not days. Sphere: Related Content
Let's back up. I recently posted a chart which tracks equity market neutral strategies: in essence a cross section of quant funds for which there is public performance tracking. The chart is presented below.
There is not much publicly available data to follow what goes on in the mystery shrouded quant world. However, another chart that tracks the market neutral performance is the HSKAX, or the Highbridge Statistical Market Neutral Fund, presented below. As one can see we have crossed into major statistically deviant territory, likely approaching a level that is 6 standard deviations away from the recent norms.
What do these charts tell us? In essence, that there is a high likelihood of substantial market dislocations based on previous comparable situations. More on this in a second.
Why quant funds? Or rather, what is so special about quant funds? The proper way to approach the question is to think of the market as an ecosystem of liquidity providers, who, based on the frequency of their trades, generate a cushioning to the open market trading mechanism. It is a fact that the vast majority of transactions in the market are not customer driven buy/sell orders, but are in fact high frequency, small block trades that constantly cross between a select few of these same quant funds and program traders.
This is a market in which the big players are Renaissance Technologies Medallion, Goldman Sachs and GETCO. Whereas the first two are household names, the last is an entity known primarily to quant market participants. Curiously, the Philosophy section in GETCO's website exactly captures the critical role that quant funds play in an "efficient" market.
What’s good for the market is good for GETCOA good example to visualize the dynamic of this liquidity "ecosystem" is presented below.
GETCO’s strategy is to align our business plan with what is best for the marketplace. We earn our revenues by providing enhanced liquidity and efficiency to electronic financial markets, which in turn results in lower costs for market participants (e.g. mutual funds, pension funds, and individual investors).
In addition to actively trading, we partner with many exchanges and their regulators to increase transparency throughout the industry and to create more efficient means for the transference of financial risk.
In order to maintain market efficiency, the ecosystem has to be balanced: liquidity disruptions at any one level could and will lead to unexpected market aberrations, such as exorbitant bid/ask margins, inability to unwind large block positions, and last but not least, explosive volatility: in essence a recreation of the market conditions approximating the days of August 2007, the days post the Lehman collapse, the first November market low, the irrational exuberance of the post New Year rally, and the 666 market lows.
The above tracking charts indicate that something is very off with the "slow", "moderate" and "fast" liquidity providers, indicating that liquidity deleveraging is approaching (if not already is at) critical levels, as the vast majority of quants are either sitting on the sidelines, or are merely playing hot potato with each other (more on this also in a second). What this means is that marginal market participants, such as mutual and pension funds, and retail investors who are really just beneficiaries of the liquidity efficiency provided them by the higher-ups in the liquidity chain, are about to get a very rude awakening.
Also, it needs to be pointed out that the very top tier of the ecosystem is shrouded in secrecy: conclusions about its state can only be implied based on observable metrics from the HSKAX and HFRXEMN. It is safe to say that any conclusion drawn based upon observing these two indices are likely not too far off the mark.
Skeptics at this point will claim that it is impossible that quant and program trading has such as vast share of trading. The facts, however, indicate that not only is program trading a material component of daily volumes, it is in fact growing at an alarming pace. The following most recent weekly data from the New York Stock Exchange puts things into perspective:
According to the NYSE, last week program trading was 8% higher than the 52 week average, which on almost 4 billion shares is a material increase. It is probably safe to say that the 1 billion in program trades last week does not account for significant additional low- to high-frequency trades originated at non NYSE members, implying the real number for the overall market is likely even higher. Some more program trading statistics: principal trading is running 21% above 52 week average, agency trading is 11% below average, while NYSE weekly volume is running about 9% below 52 wk average.
A very interesting data point, also provided by the NYSE, implicates none other than administration darling Goldman Sachs in yet another potentially troubling development. The chart below demonstrates the program trading broken down by the top 15 most active NYSE member firms. I bring your attention to the total, principal, customer facilitation and agency columns.
Key to note here is that Goldman's program trading principal to agency+customer facilitation ratio is a staggering 5x, which is multiples higher than both the second most active program trader and the average ratio of the NYSE, both at or below 1x. The implication is that Goldman Sachs, due to its preeminent position not only as one of the world's largest broker/dealers (pardon, Bank Holding Companies), but also as being on the top of the high-frequency trading/liquidity provision "food chain", trades much more often for its own (principal) benefit, likely in tandem with the other top dogs on the list: RenTec, Highbridge (JP Morgan), and GETCO. In this light, the program trading spike over the past week could be perceived as much more sinister. For conspiracy lovers, long searching for any circumstantial evidence to catch the mysterious "plunge protection team" in action, you should look no further than this.
Following on the circumstantial evidence track, as Zero Hedge pointed out previously, over the past month, the Volume Weighted Average Price of the SPY index indicates that the bulk of the upswing has been done through low volume buying on the margin and from overnight gaps in afterhours market trading. The VWAP of the SPY through yesterday indicated that the real price of the S&P 500 would be roughly 60 points lower, or about 782, if the low volume marginal transactions had been netted out. And yet the market keeps on rising. This is an additional data point demonstrating that the equity market has reached a point where the transactions on the margin are all that matter as the core volume/liquidity providers slowly disappear one by one through ongoing deleveraging.
Unfortunately for them, this is not a sustainable condition.
As more and more quants focus on trading exclusively with themselves, and the slow and vanilla money piggy backs to low-vol market swings, the aberrations become self-fulfilling. What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme. As the overall market volume is substantially lower now than it has been in the recent past, this strategy has in fact been working and will likely continue to do so... until it fails and we witness a repeat of the August 2007 quant failure events... at which point the market, just like Madoff, will become the emperor revealing its utter lack of clothing.
So what happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible: large swings on low volume, massive bid-offer spreads, huge trading costs, inability to clear and numerous failed trades. When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility. Furthermore, high convexity names such as double and triple negative ETFs, which are massively disbalanced with regard to underlying values after recent trading patterns, will see shifts which will make the November SRS jump to $250 seem like child's play.
For readers curious about just how relevant liquidity is in the current market, I recommend another recent post that discusses DE Shaw's opinion on the infamous basis trade, in which their conclusion was that establishing a basis trade, which is effectively the equivalent of selling a put option on market liquidity, ended up in massive financial carnage as the market rolled from one side of the trade to another. Is it possible that what the basis trade was for credit markets (most notably Citadel, Merrill and Boaz Weinstein), so the quant unwind will be to equity markets?
So when will all this occur? The quant trader I spoke to would not commit himself to any specific time frame but noted that a date as early as next Monday could be a veritable D-day. His advice on a list of possible harbingers: continued deleveraging in quant funds as per the charts noted above, significant pre-market volatility swings as quants rebalance their end of day positions, increasing principal program trading by Goldman Sachs on decreasing relative overall trading volumes, ongoing index VWAP dislocations. One thing is for certain: the longer the divergence between real volume trading/liquidity and absolute market changes persists, the more memorable the ensuing market liquidity event will be. At the end of the day, despite the pronouncements by the administration and more and more sell-side analysts that the market is merely chasing the rebound in fundamentals in what has all of a sudden become a V-shaped recovery, the "rally" could simply be explained by technical factor driven capital-liquidity aberrations, which will continue at most for mere weeks if not days. Sphere: Related Content
Bookmark this post with:
Subscribe to:
Posts (Atom)
