Iridian Asset Management Explains Why Stock Picking No Longer Matters Thanks To The Fed

Tyler Durden's picture

One of the long-term themes on Zero Hedge over the past two years has been that beginning in 2009, following the Fed's total incursion in all capital markets, mostly in equities due to the highest delta on consumer net wealth as a function of stock price upside, any type of traditional stock picking (long-short but also virtually everything) has ceased to matter. Various hedge fund manager retirements in 2010 merely confirmed the acceleration of this trend. The complete elimination of volatility in what has become a policy weapon merely means that day traders are also leaving stocks in droves and heading for places where the Fed's complete domination has yet to manifest itself, such as commodities, bonds and FX, where vol has surged over the past two years. Today, we present Iridian Asset Management's most recent market thoughts, which confirms the observations in the Morgan Stanley report posted a few days ago on Zero Hedge discussing the firm's fears that a 2007-like quant collapse is coming as there is no longer any normalcy in the market, on why stock picking as a business is now dead. Obviously, we couldn't agree more.

From Iridian Asset Management:

How bad is this combination of high correlation and low volatility for stock pickers? Consider the traditional factors of stock picking differentiation, factors such as momentum, growth, and value. The squelching of volatility in the equity market, which some have characterized as the shooting of a tranquilizer dart into an elephant, combined with the increase of risk-on / risk-off behavior, has led to a phenomenal muting of these factors. The Morgan Stanley quant team shows this result dramatically in the chart below.

In this way, then, the story of 2010 was very different from the story of 2009. In 2009 stock picking mattered, but the stock picking that worked was to pick the most beaten-down stocks possible, the cheaper the better, regardless of other characteristics. Any factor with price in the denominator was a big winner. Any other factor was a big loser. In 2010, however, there were no big winning factors or big losing factors. Everything was washed out in a tsunami of liquidity, so that the only winning bet was to be short volatility. Or as expressed earlier (and in some memorable You Tube cartoons), “Buy the dip!” In a year where 94% of total S&P 500 gains occurred in the first trading day of each month, where hedge funds portfolios traded en masse up and down more than ever before, where short selling has become the almost exclusive province of HFT algorithms, where trading positions and limit orders are arbitraged away faster than ever, can one really claim that fundamental stock picking mattered one bit?

The real question, of course, is whether this hostile environment for stock pickers is likely to change. We believe that that likelihood of a change in our favor is very high. Can 2011 be a repeat of 2009, where buying cheap stocks (and where “cheap” is understood purely as a function of price) is the winning allocation? We think it unlikely with an S&P 500 back over 1200, with stocks routinely trading at doubledigit multiples of sales and triple-digit multiples of earnings. Can 2011 be a repeat of 2010, where correlations continue to increase and volatility continues to decline? Certainly it’s possible, if QE 2 morphs into QE’s 3, 4, and 5, if the Plunge Protection Team re-defines its role as the No Down Day Protection Team, and if the Federal Reserve continues to engage in explicit asset bubble-blowing.

But the truth is that the world remains, to use Nassim Taleb’s terminology, a remarkably un-robust place. The truth is that volatility may have been driven out of the equity market, but is running rampant in the much larger forex, commodity, and US Treasury markets. The truth is that political risk – meaning the chances of a disastrous policy decision in the US, China, or Europe with enormous unintended consequences – has never been greater. The truth is that securitization is still dead, sovereign debt is systemically mispriced, and the Great Moderation is over.

We are not saying that the sky is falling. On the contrary, we believe that there is a meager but selfsustaining recovery taking root in the global economy. This is what we mean by muddling through. But the impact of unprecedented fiscal and monetary stimulus around the world has been to mask the winners and losers within this muddling through process, to make, in the words of Huey P. Long’s campaign slogan, “Every Man a King.” In a free money environment every financial asset is a king. It is impossible to short stocks and the only imperative is to buy. But at some point the stimulus ends. In fact, as anticipatory mechanisms, markets require only the expectation of a reduction in stimulus for a shift in dynamics to occur. When that occurs (not if, but when), synchronized co-movement in asset classes should decline. Volatility should, if not increase, at least achieve a level commensurate with real economic risks. Stock picking should matter because the natural separation between winners and losers in a muddle through world will be visible once again.

We submit that – unless you are prepared to believe that the relationship between State and Market has been permanently altered, such that volatility can be artificially squelched and correlations can be artificially maintained forever – then this is a good time to go long stock picking. From a top-down perspective, we believe that historic wide spreads between correlation and volatility provide a compelling risk/reward opportunity for portfolio managers who are naturally short correlation and naturally long volatility.

We are naturally short correlation because we are stock pickers, because we have non-consensus, divergent opinions on future winners and losers. We are naturally long volatility because these divergent opinions are based on event-driven and thematic catalysts. Typically, about half of our portfolio consists of stocks that may be principally understood as an expression of a theme, and the other half will be populated by individual names with discrete catalysts. Often events generate an investment theme and in this way they interact, although we caution our investors not to get too carried away with the distinction between events and themes and to remember that these are ways for us to bring what we hope is a divergent view to the companies we examine. Whether categorized as an event or as a theme, our catalysts can all be defined as idiosyncratic agents of change.

Full report, which to frequent readers will have little new to add...


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Cleanclog's picture

As CNBC declares another day where we'll push higher - never mind anything else.  TPTB have spoken and nothing else matters.

Do you feel the wealth effect yet?

Racer's picture

I feel the poverty affect.. paying for all the high priced food and fuel!

Sudden Debt's picture

just put on those knee-pads and go ask for a raise!






I have no idea what that means but it seems to be a popular quote these days...

Racer's picture

I can't afford to keep buying them the rate I wear them out!

slackrabbit's picture

Wow, you got knee pads?

<turns to another begger beside him> He must be one of those elites!

Reggie Middleton's picture

fears that a 2007-like quant collapse is coming as there is no longer any normalcy in the market, on why stock picking as a business is now dead


You damn sure got that right!!!

Sudden Debt's picture

I wonder if that system works like the Mob Protection Team.The MPT so to speak.




Oh yeah... my cousin Vinny looks for a job. CEO would be something right up his alley. I'll give you 2 minutes to give me the deed of this place and for you to fuck off!


SheepDog-One's picture

I actually hope it keeps getting worse every day, already even people never in the markets know its all just BS. Keep ruining everything for a quick little high ya morons! Just means their demise draws nearer.

Tense INDIAN's picture

but we really should thank the FED for this opportunity the broder market looks much more easier......with the VOLATILITY as bonus

alien-IQ's picture

the /ES spiked 3.5 points in the time it took me to read this...thus confirming the validity of what I just read.

meanwhile, the USD is getting another Rikers Island shower shanking.

just another day in the neo-feudalistic gulag casino.

Cdad's picture

This whole retest of S&P 1300 has been on the back of criminal syndicate Wall Street bankers "shanking" the dollar.  There is only one freakin' trade here...kill the dollar, long anything else.  And of course, Ben Bernanke is fueling the trade with his printing.  And for this, criminal syndicate Wall Street bankers ask only to be the highest paid people in the nation.  Gee...thanks. 

It will be this very dollar destruction fact that will finally drive the masses to rage.  It will arrive, of course, in the form of prices...on anything else

This criminal class of people needs to be removed from the system before the system can finally function normally.  There is no doubt about this and no short cut to clean up the mess.  We need pink slips...let's say 100,000 to start.

And where is Ron Paul?  Where are the financial services hearings?

Uncle Sugar's picture

What happens when QE2 ends. Does the market tank so the Fed has cover for QE3?  Do all the commodities soaring now go in the shitter?

Rogerwilco's picture

"Various hedge fund manager retirements in 2010 merely confirmed the acceleration of this trend."

Smart money started leaving the party months ago. It's 2 AM, but Ben keeps filling the punch bowl for the drunken bag-holders still hanging around.

eckart's picture

Very dangerous market here...stinks of summer 08

ak_khanna's picture

The stock, commodity and currency exchanges have been reduced to gambling dens whereby the more powerful traders with deep pockets move the markets to maximize their own profits at the expense of the remaining not so powerful players. The big boys have enormous money power to move the markets in the direction which results in maximum profits for themselves. They effectively use the media to lure the other players in the market to a position where they would incur maximum loss. It is similar to rounding up maximum sheep before shutting the doors of the slaughter house.

The markets will fall only when the banksters have eliminated all the short positions and only they themselves have positioned themselves to profit when the market falls


When an unexpected world event catches the banksters with their pants down and the softwares they use to rig the markets go berserk beyond their control.

buzzsaw99's picture

buy index etfs and enjoy the ride!

system failure's picture

Exactly dead on report, for example, get ready to see today's ramp job on minimal POMO today at 10 AM, 1st day of the month, and all systems ready to crank it out into the stratosphere. 5 more minutes until fireworks go off......

system failure's picture

Totally predictable anymore and horrid in their approach to ramp the obvious at the moment of decisions between falling to its death or a must need ramp. And as always with the Benank put, we have the miraculous ramp and Hamy Wanger can educate us on his wonderous insight. LOL

system failure's picture

Okay, its time to go short now, since TPTB have projected the 10:30 am Rydex ETF cut off times to think long and murder them back down now. They are such cruel inhumane individuals.  

system failure's picture

Yes, the POMO MOJO ran out of money and the death spiral begins today....the Bernank Puts account just received a margin call, reality check and nuts are firmly placed into a vise. Maybe they can afford the medication for nervous leg movement condition noted in Jeethner with Obamacare...

Salinger's picture

has anyone seen Rosie? I know its groundhog day tomorrow but maybe he popped out of his cave early and saw the S&P

Seasmoke's picture

is it even possible to day trade with low volume and low volatility

I am more equal than others's picture

PPT = Penis Protection & Trenchcoat.  The world is being gang-raped by this action and when world events are too big (PPT rips, tears and the Bernake smegma comes in contact with rape victim) and finally overwhelms the Fed, the losses will wipe out all currencies and investments.  Pump away Fed.  Pump away.  The Trenchcoat is weakening with every stroke.

Robslob's picture

Funny their efforts to take care of only big banks they are killing off the entire financial community (and they are just now figuring it out).

I mean who needs a financial advisor anymore...BTFD?

apberusdisvet's picture

PMs slammed at 10am; they don't give up do they; I guess that they were afraid the Jordan news would cause gold to spike, as it should have.  Even the most uninformed should realize what is going on;  oops I forgot that less than 50% of HS graduates can read at a 10th grade level.

whatz that smell's picture

xom parabolic.... market cap has exploded $100 billion since sept. 2010... wealth effect, bitchez!

praise be the bernank! may he blow bubbles a thousand years!

campag's picture

"day traders leaving stocks in droves"   cant see why ? its great to be long  a market that is never down for long and always gets bid up in last half hour.

BaronG's picture

Reading the Dying of Money by Jens Parrson as recommended a while ago by TD. Great book. Highly suggest reading it - really helps explain a lot that's going on these days, and puts it into historical context.

gwar5's picture

I got out of the market at the right time in Nov 2007. I was more lucky than smart. The recent interventions by the Fed are astonishing and confirms the creepy feeling I got then. More devastation will result.

Trifecta Man's picture

You can look at what people say.  Then look at what they do.  Iridium appears to be doing the opposite of their argument.  And I don't see the word contrarian in Tyler's summary.

The buy everything approach to the stock market intuitively sounds like a loser.  I am not the greater fool that buys big bank stocks with all their false accounting.  I will buy solid mining, energy, or food stocks that hedge a Zimbabwe-like dollar in the long term.

topcallingtroll's picture

Stock picking has almost always been for fun since 90 percent of returns depend on asset class selection. Very little alpha generated over a lifetime. However we do find the occasional person who flips ten heads in a row, so we hand him our coins to flip for us.

HUGE_Gamma's picture

its a game of picking stocks that move >

Double down's picture

Very good article

Pat Hand's picture

What a maroon.

it's been a great stockpicking environment since Nov 2008.  Just have to decorrelate your bets correctly.

The MS stuff is completely wrong - it's an embarrassing excuse for analysis.

Deutsche bank had a good piece Friday completely shredding the MS piece. Hunt it down for some enlightenment.

I have no idea why anyone would invest with Iridian.