Kass On Quantative Trading
One of the hidden influences on stocks in recent years is a new type of algorithmic program trading. It has become one of the main players on Wall Street. Tuesday The Street.com's Doug Kass weighed in on "Quant's" growing influence in the market. Excerpt below. Highlights mine.
"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).
"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).
These words resonate to me in the current investment setting as many investors and traders are assuming the most benign of economic outcomes and have begun to dance and party like it's 1999. The media's talking heads are doing their best to fuel the celebration, just as they were at DJIA 14,000 before the market crashed last year. It is also the same group of cheerleaders that was mired in depression eight short months ago.......
.....For now, though, let's throw away the fundamentals, the Fed, talk of bubbles and opinions on the economic trajectory as there might be an outside influence that is playing an increasingly more influential role and could help to explain some of the persistency of the market's advance since the summer.
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!).
Over the course of the past few weeks, I have investigated the increased role of momentum-based and high-frequency-trading quant funds. Though hard to "quantify," I believe that the disproportionate role of these funds, which use algorithmic formulas in their directional trading strategy, is shockingly influential in the current momentum-based climate and is serving as an "invisible hand."
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. 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....
The trade of shorting the U.S. dollar, buying long-dated assets like bonds and stocks, and barreling into commodities (read: gold) and other non-dollar assets is impervious to fundamentals and is likely contributing (in part) to bubble-like conditions in several asset classes. And stocks have benefited from this wave.....
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 (GS) pays!
......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.
I have seen many bubbles in my 30-plus years in the investment business. There is a giant bubble in quant funds, and their outsized influence in buying stocks, bonds and commodities might soon be approaching the height its of popularity.
As was the case when Citigroup's (C) Chuck Prince was dancing in 2007, we never know when and how these trends extinguish themselves. We do know, however, that any serious break in momentum in some of the bubblicious asset classes (perhaps caused by economic disappointment) could precipitate indigestion within the quant fund industry that could weigh on the stock market, more so than many now believe possible.
.....For now, though, let's throw away the fundamentals, the Fed, talk of bubbles and opinions on the economic trajectory as there might be an outside influence that is playing an increasingly more influential role and could help to explain some of the persistency of the market's advance since the summer.
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!).
Over the course of the past few weeks, I have investigated the increased role of momentum-based and high-frequency-trading quant funds. Though hard to "quantify," I believe that the disproportionate role of these funds, which use algorithmic formulas in their directional trading strategy, is shockingly influential in the current momentum-based climate and is serving as an "invisible hand."
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. 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....
The trade of shorting the U.S. dollar, buying long-dated assets like bonds and stocks, and barreling into commodities (read: gold) and other non-dollar assets is impervious to fundamentals and is likely contributing (in part) to bubble-like conditions in several asset classes. And stocks have benefited from this wave.....
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 (GS) pays!
......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.
I have seen many bubbles in my 30-plus years in the investment business. There is a giant bubble in quant funds, and their outsized influence in buying stocks, bonds and commodities might soon be approaching the height its of popularity.
As was the case when Citigroup's (C) Chuck Prince was dancing in 2007, we never know when and how these trends extinguish themselves. We do know, however, that any serious break in momentum in some of the bubblicious asset classes (perhaps caused by economic disappointment) could precipitate indigestion within the quant fund industry that could weigh on the stock market, more so than many now believe possible.
posted by CR English at 6:35 AM
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