Sunday, April 19, 2009

Equity Rally Reaches Escape Velocity

The “crap rally” accelerated further on Friday, one of the lowest volume options expiration days in recent memory. Gravity defying common equity prices of fundamentally "basket case" businesses advanced further. The move can no longer be described as parabolic. A space shuttle launch trajectory is the most accurate depiction of the move. The only question is if this is mission STS-51-L of Challenger or STS-107 of Columbia. We will know the answer fairly soon.

The MSM did its best to give legitimacy to insanity. In a widely reported State Street Institutional equities flows report from April 18, the FT reported: "Institutional investors are backing this rally," says the trust bank in its latest research. "The belle of the ball is the US," it notes, highlighting the fact that the US institutional equity inflows that it measures are near their highest levels in 12 years. The same high quality outfit reported on March 26: “State Street Hedge Fund Study Shows Institutional Investors Remain Committed to Hedge Funds Despite Moderate Decline in Allocations”. It’s all good in the world of mutual and hedge funds. That leaves one wondering where all these devastating redemptions came from. Probably from modest declines in allocations. The same report also says: “Another encouraging sign for alternatives is increased institutional interest in private equity funds.” Yes, we read it right, increased interest, not a disdain after shocking losses. Good things always come in bunches.

But back to April 18th FT article: “Brad Durham, managing director at Emerging Portfolio Fund Research, says that since March 11, there has been an inflow of $3 billion into US equity funds, excluding exchange-traded funds. Mr Durham adds that ETFs have seen significant outflows in the past six weeks, which suggests short covering as these were actively used to bet on the market falling in price earlier this year.”

All good news: Index shorts are covering, US equity funds inhaling billions of inflows. Let’s use NYSE Program trading statistics to put this cool $3 billion into perspective. For the past few weeks GS principal only Program Purchases Traded (PPT) averaged about 1 billion shares daily. A modest average price assumption of $15 per share this will take to $15 billion per day. A further assumption of 15 trading days from March 11th to April 1st brings us to $225 billion of principal traded. Mighty institutions make a move and win with a huge size of 1.34% of the Goldman-only PPT flows.

The most respected name in fund flow tracking is Investment Company Institute (ICI). ICI publishes the very useful “Trends in Mutual Funds Investment” report that can be found here:

Per ICI, total outflows from domestic equity mutual funds amounted to -$21.2 billion for the weeks of 3/4/2009 to 4/1/2009 and $-7.7 billion from 3/11/2009 to 4/1/2009. There were no meaningful inflows, just on opposite – funds lost assets.

According to the latest 13F filing, Jim Simmons’s perennial jackpot winner hedge fund Renaissance Technologies (where only the internal Medallion fund actually wins) reported about $27 billion of long positions. Only 0.14% of fund’s positions remained unchanged from the previous reporting period. A simple assumption of corresponding short and short hedged positions applied to Mr. Simmons’ long /short fund can bring us to gross market exposure of $54 billion. Taking it further and assuming Mr. Simmons’s behemoth 10 business days holding period (very mild assumption for this fast trading fund) will take us to $216 billion of trading principal per month or about 10x of vanilla money institutional outflows.

Yes, we can’t compare apples to oranges – net fund flows and gross principal traded, but this is a very useful exercise in relative scale of vanilla, slow money and fast trading.

The relative scale of trading flows validates the statement of Duncan Niederauer, chief executive of NYSE Euronext, to the FT that this rally had been driven by short-term traders. Short-term quant traders unwinding positions and dying under the unbearable weight of their own size.

Dear quants: we repeat our appeal to our from the open letter published Friday. The market is a good thing - let's not destroy it.

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