This page has been archived and commenting is disabled.

Quant Wipeout In Process?

Tyler Durden's picture





 

On Monday we posted an article, highlighting Morgan Stanley's observations that we may be on the verge of an August 2007-like quant wipeout. Considering what is happening today, it may have proven eerily prescient. Below, we repost the full thing as some may not have taken it seriously the first time around.

Morgan Stanley Sees Recent Market Conditions As Reminiscent Of August 2007 Quant Crash, As "Don't Fight The Fed" Groupthink Trade Fizzles

Something scary this way comes from Morgan Stanley's Quantiative and Derivative Strategies: "market
conditions over the last two weeks are somewhat reminiscent of that
during the August 2007 ‘Quant Crisis’. In only a few days, a number of
quantitative long-short equity funds experienced unprecedented losses in
seemingly ‘normal’ market conditions.
We do not suggest here
that the magnitude of hypothetical losses match those from 2007,
however, there is little question that the rotation has drawn attention
of many quant investors." In other words, the massive groupthink trade
that we have been warning about for months may be about to claim its
first mass casualties.

The just released report by author Charles
Crow elaborates what many have been suspecting, yet few dared to voice:
"Recent substantial factor movements in Europe have contributed to
portfolio volatility and, in some cases, abrupt performance degradation.
Portfolios positioned to take advantage of prevailing factor trends may have suffered substantially over the last two weeks."
Is the groupthink trade about to end? If so, does that mean the funds
will be forced to stop "not fighting the Fed" as this is really the only
factor-driven trade that has made sense. If so, we have reached the
critical point where being aligned alongside the Fed has no incremental
marginal returns, at least for the non-Primary Dealers. This could
promptly transform to a watershed event, especially since as Morgan
Stanley adds, the market currently has "relatively low liquidity" to
absorb the fringe moves.

More details from Morgan Stanley:

Recent
substantial factor movements in Europe have contributed to portfolio
volatility and, in some cases, abrupt performance degradation.
Portfolios positioned to take advantage of prevailing factor trends may
have suffered substantially over the last two weeks.

These
rapid and significant reversals of factors returns have caught many
investors – quant and fundamental managers alike – on the wrong side of a
trade.
The broad rotation also raises the question whether
this represents the beginning of a secular shift back into Value at the
expense of Momentum, Quality and Growth. Alternatively, the rotation may signify an idiosyncratic quant portfolio rebalancing in a market of relatively low liquidity.

We
first seek to place the recent factor returns in a historical context.
Exhibit 1 presents the weekly cumulative factor performance over the
first three weeks in January. The fundamental factors span major
investment styles, including Value, Growth, Momentum, Financial
Leverage, Quality/Profitability and Free Cash Flow. To appreciate the
recent rotation, also included is the cumulative performance of each
factor over the entirety of the 2010 fourth quarter.


The
above performance is sorted according to the week of January 17 – a
period that realized substantial and persistent factor returns. It is
evident that the rotation began over the week of January 10
(specifically, our data suggests it started on Tuesday, January 12).

The
magnitude of weekly factor performance is striking and, in some cases,
exceeds absolute factor performance over the entirety of 4Q10.
Quant
portfolios positioned to exploit recent Style trends – portfolios
potentially long Quality (e.g., ROI), Growth (e.g., 1-Yr Est. EPS
Growth), and Momentum (e.g., 12-Mth Price Momentum) – have endured
violent reversals in many underlying positions.

For example,
12-Mth Price Momentum gained 4.2% over 4Q10, yet declined 5.3% during
the week of the January 17. Negative Momentum is an indication of broad
mean-reversion in the underlying equity market (e.g., ‘churn’). In fact,
the factor realized -10.0% over the last eight trading days through
unrelenting negative performance. The factor’s return exceeded
2-standard deviations moves on four of the last eight days. On January
12 – the first day of the ‘rotation’ – the factor realized -2.6% on a
single day (a 3.9-standard deviation event).

All of this
factor turbulence was realized in a range-bound equity market. Despite
the recent increase in realized volatility, absolute levels remain
historically low and expected short-term volatility has declined over
the last ten sessions – see Exhibit 2. The VStoxx Index, which measures
the cost of protecting against a decline in the Euro Stoxx 50 Index,
declined 3.1% over the week of January 17.


Thus,
market conditions over the last two weeks are somewhat reminiscent of
that during the August 2007 ‘Quant Crisis’. In only a few days, a number
of quantitative long-short equity funds experienced unprecedented
losses in seemingly ‘normal’ market conditions. We do not suggest here
that the magnitude of hypothetical losses match those from 2007,
however, there is little question that the rotation has drawn attention
of many quant investors.

Exhibit 3 emphasizes the
magnitude of recent daily factor returns in Europe. The +/-1 standard
deviation bands from September 1, 2010 to January 21, 2011 overlay the
daily factor performance. A number of factor returns over the last two
weeks have well exceeded 2-standard deviation events. Despite the recent
uptick in market volatility, factor trends since the start of the
rotation on January 12 have been largely one-sided.

One
assumption from Morgan Stanley is that we are seeing an
unprecedented-scale sector rotation by the quant community as it
attempts to diversify from a huge one-sided trade, which is forcing many
funds to get blown out of the water on loser positions.

Sector-level
excess returns of the two factor quintiles suggest a relatively
broad-based rotation. Book/Price, that has gained 5.8% over the last two
weeks, has largely seen its ‘cheap’ portfolio outperform across
sectors. Similarly, the ‘expensive’ segment across sectors has
concurrently underperformed.

Analogously, the best performing
names within our 12-Mth Price Momentum have largely underperformed
consistently over the last two weeks, while the worst performing names
have outperformed.

Although there are exceptions (e.g., -3.1%
excess return within the worst performing Info Tech portfolio on January
13, which is a relatively concentrated European sector), the overall
performance of the two factors appear to be driven uniformly across
sectors. An open question is whether this rotation is short-lived or we
will be experiencing a continuation of the reversal in the coming days
and months.

A number of quant managers have adapted their
approach to investing by taking into consideration risk factors such as
crowded trades and abrupt style rotation. While some would have been
less exposed to this recent trend, the environment continues to be
challenging.

Our
less than politically correct interpretation of this finding, as noted
above, is that the traditional "don't fight the Fed" trade, validated by
whatever combination of factors, is now on its last breath, and all
those who are caught in it last, will see massive losses, ergo the
scramble to rotate out. Should this indeed be the case, we are due for
some material market turbulence as the quants struggle to reposition
themselves in a market which is now longer dependent on the day to day
whims of Ben Bernanke and the "Sack Frost" POMO dynamic duo. Lastly, if
indeed we are in the midst of an August 2007-type of Hurricane, it is
about to get a whole lot messier. Add Tom DeMark's expectations for an
11% decline in stocks, and not even the "Fed Frontrunners" may be able
to continue the melt up at this point.

 


- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Fri, 01/28/2011 - 13:05 | Link to Comment oh_bama
oh_bama's picture

This is really old news...

 

but in any case, should I BTFD now?? Guys I am a newbie... please help!!

Fri, 01/28/2011 - 13:24 | Link to Comment LostWages
LostWages's picture

BTFD will continue to work ..... until it doesn't.  Do you feel lucky?

Doubtful many new positions will be taken that will be held over the weekend, unless gold and oil.

But then WTF do I know?  Step up and spin the wheel!  Everybody wins in the Casino Bernank.

Fri, 01/28/2011 - 13:29 | Link to Comment Central Wanker
Central Wanker's picture

You should definitely BTFD, but remember to buy at the bottom.

Fri, 01/28/2011 - 14:37 | Link to Comment spinone
spinone's picture

Do you pick up dimes in front of a steamroller?  Do you gamble in a rigged casino?  You can make money there too.

Fri, 01/28/2011 - 13:08 | Link to Comment apberusdisvet
apberusdisvet's picture

Hmmm.  This could be the start of an eventual 30% or more correction.  I thought it would start around April Fool's Day (appropriate, teehee), but Egypt may turn out to be the earlier trigger.

Fri, 01/28/2011 - 13:10 | Link to Comment HarryWanger
HarryWanger's picture

Very doubtful. Again, we could pull back to 1250 at some point but there are just too many buyers coming in on these 1-2% dips that it's going to be difficult to even see that.

Fri, 01/28/2011 - 13:17 | Link to Comment hedgeless_horseman
hedgeless_horseman's picture

Direct some of those buyers to GM, down 5.5%.

They can find it under "G" for Government.

A very safe investment...as the company's stock has not gone to zero for many months.

Fri, 01/28/2011 - 13:17 | Link to Comment firstdivision
firstdivision's picture

With the world problems going on...think it will fall back to 1100's by May.

Fri, 01/28/2011 - 13:20 | Link to Comment SheepDog-One
SheepDog-One's picture

Easy come, easy go Harry.

Fri, 01/28/2011 - 13:20 | Link to Comment economessed
economessed's picture

Harry, are you talking about gold? 

(pregnant pause)

Fri, 01/28/2011 - 13:32 | Link to Comment NorthenSoul
NorthenSoul's picture

With Egypt (and now Syria) in deep doodoo, what Tyler tweeted earlier: WTI = 140$ easy.

Fri, 01/28/2011 - 15:57 | Link to Comment homersimpson
homersimpson's picture

Yes I'm sure "too many buyers" are waiting to prop up your APPL shares..

Why don't you just go long YHOO like you did back in the day and gamble some more? Break out those "tight stops" so you can prevent yourself from getting a 30% loss in one day... LOL

Fri, 01/28/2011 - 16:01 | Link to Comment homersimpson
homersimpson's picture

Yes I'm sure "too many buyers" are waiting to prop up your APPL shares..

Why don't you just go long YHOO like you did back in the day and gamble some more? Break out those "tight stops" so you can prevent yourself from getting a 30% loss in one day... LOL

Fri, 01/28/2011 - 13:41 | Link to Comment sunny
sunny's picture

Nah, as soon as Benny realizes what's going on he'll pump a few Billion$ into Apple and everything will be better.

sunny

Fri, 01/28/2011 - 13:09 | Link to Comment Henry Chinaski
Henry Chinaski's picture

This is looking to be one of the more interesting days since the flash crash.

Fri, 01/28/2011 - 13:10 | Link to Comment John McCloy
John McCloy's picture

No the unqualified clown Sec. Clinton is on TV. These elites are completely out of touch with humanity.

Fri, 01/28/2011 - 13:24 | Link to Comment Rick64
Rick64's picture

 They always are. Why should they care about the inflation the FED is causing. They can still afford anything they want.

Fri, 01/28/2011 - 13:27 | Link to Comment Wynn
Wynn's picture

In true Clinton fashion, she'll wait to see how the wind blows before making a decision .. one she can backtrack on, when the next gust hits.

Fri, 01/28/2011 - 13:53 | Link to Comment SWRichmond
SWRichmond's picture

The Egyptian crisis is a true black swan.  We knew there'd be one, didn't we?

Fri, 01/28/2011 - 14:26 | Link to Comment Pat Hand
Pat Hand's picture

Not at all a black swan.

Black swans are paradigm altering events.  Egypt is just a "typical" event.  Unpredictable, yes.  Extreme? maybe.  Black Swan? not even close.

 

Fri, 01/28/2011 - 21:17 | Link to Comment SWRichmond
SWRichmond's picture

Give it time.  If Egypt goes anti-American, les deluge.

Fri, 01/28/2011 - 13:10 | Link to Comment 99er
Fri, 01/28/2011 - 13:10 | Link to Comment Edna R. Rider
Edna R. Rider's picture

I am 100% confident between Brian Sack and JPM the SPX will make a full bloody recovery today.

Fri, 01/28/2011 - 13:11 | Link to Comment hedgeless_horseman
hedgeless_horseman's picture

PPT selling USD (Lord knows they have inventory)...which usually does the trick.

Fri, 01/28/2011 - 13:10 | Link to Comment FLUSA.com
FLUSA.com's picture

What is the Bernanke going to do?  Should be interesting....

Fri, 01/28/2011 - 13:11 | Link to Comment KevinH
KevinH's picture

market is just following aapl. nothing else

Fri, 01/28/2011 - 13:21 | Link to Comment HarryWanger
HarryWanger's picture

NAZ bouncing back hard off those lows. Losses will be cut in half by close if not more IMO.

Fri, 01/28/2011 - 13:25 | Link to Comment plocequ1
plocequ1's picture

Exactly. I am just sitting here watching.

Fri, 01/28/2011 - 13:26 | Link to Comment Miles Kendig
Miles Kendig's picture

Better money in Gold & Oil today.  Crack spreads are a screaming buy

Fri, 01/28/2011 - 17:20 | Link to Comment Ferg .
Ferg .'s picture

Nasdaq continued down . Closed near the lows .

Fri, 01/28/2011 - 17:21 | Link to Comment Ferg .
Ferg .'s picture

Nasdaq continued down . Closed near the lows .

Fri, 01/28/2011 - 17:20 | Link to Comment Ferg .
Ferg .'s picture

Nasdaq continued down . Closed near the lows .

Fri, 01/28/2011 - 13:11 | Link to Comment TruthInSunshine
TruthInSunshine's picture

Urinal cakes can't catch a bid here, folks...

This could get very interesting. Wheels may come off and drivetrains may buckle under The Bernank's nose here...especially given that The Bernank Put will cause a toxic shock to the downside if it's taken out, given that it's so much larger than Greenspan's was.

Fri, 01/28/2011 - 13:19 | Link to Comment zero intelligence
zero intelligence's picture

I'm definitely not bidding on your urinal cakes, thanks.

Fri, 01/28/2011 - 13:26 | Link to Comment TruthInSunshine
TruthInSunshine's picture

HarryWanger sells the urinal cakes. His orders are down sharply as The Bernank's actions have caused their primary ingredients to skyrocket in price.

Harry Wanger Urinal Cake Company, PLLC -

Fri, 01/28/2011 - 14:31 | Link to Comment pslater
pslater's picture

We've been living on the Bernank Put since 2008....

Fri, 01/28/2011 - 13:17 | Link to Comment sbenard
sbenard's picture

What a Bizarre day! Crude oil is up $4. Grains up! Gold and silver up sharply. Dollar up! And stocks are down sharply. Something fishy this way comes!

Fri, 01/28/2011 - 13:24 | Link to Comment John McCloy
John McCloy's picture

No worries. 33 Liberty and the magic HFT boxes will have everything back to normal with the hour.

Clinton has spoken and although she may have been saying gibberish the underlying message was.."Buy The Fucking Dip"

Fri, 01/28/2011 - 13:29 | Link to Comment plocequ1
plocequ1's picture

Exactly. The market reversal to the upside is just a few keystrokes away. I believe its called the ass button

Fri, 01/28/2011 - 13:22 | Link to Comment SheepDog-One
SheepDog-One's picture

No thanks Harry, I dont need any urinal cake bids today.

Fri, 01/28/2011 - 13:24 | Link to Comment alter ego
alter ego's picture

Treasury yields were dangerously high during

the last days.

I guess the FED strategy is to crash stocks in

order to defuse the pressure on Bonds.

Then when a major correction comes (as I

guess we are entering) the Fed will appear with

a QE3 in order to save the planet.

Saving the planet is figurative.

They will try to repeat this pattern until there is

no more paper in the world to print their

worthless currency.

 

 

Fri, 01/28/2011 - 13:26 | Link to Comment SheepDog-One
SheepDog-One's picture

QE3 to ensure the entire world goes into full food famine riot and revolution mode? Well, that COULD actually be the plan!

Fri, 01/28/2011 - 14:08 | Link to Comment InconvenientCou...
InconvenientCounterParty's picture

roger that.

Accidents and blunders can qualify as plans if the results turn out well. Did Reagan intend to implode the USSR with "borrow and spend" economics? Some would say yes. Could that be used as a template to topple other large communist states? I'm going to go with "yes" on that one.

BTW, for any Reagan worshipping junkers out there, please wrap your lips around my exhaust pipe whilst I floor it.

Fri, 01/28/2011 - 14:35 | Link to Comment slaughterer
slaughterer's picture

Starve the competition, make em riot and close themselves down.  US then has last runner advantage.  It is in a recent Citigroup report.

Fri, 01/28/2011 - 14:35 | Link to Comment slaughterer
slaughterer's picture

Starve the competition, make em riot and close themselves down.  US then has last runner advantage.  It is in a recent Citigroup report.

Fri, 01/28/2011 - 14:35 | Link to Comment slaughterer
slaughterer's picture

Starve the competition, make em riot and close themselves down.  US then has last runner advantage.  It is in a recent Citigroup report.

Fri, 01/28/2011 - 13:25 | Link to Comment Miles Kendig
Miles Kendig's picture

Smoke 'em

Fri, 01/28/2011 - 13:37 | Link to Comment SpeakerFTD
SpeakerFTD's picture

The real question is whether the immigrant youths of France and other Med countries will be inspired by all this video to go outside and break something. 

If so, Euro could drop 20 cents in a month (ala 08 crisis).

 

Fri, 01/28/2011 - 13:28 | Link to Comment CapitalObserver
CapitalObserver's picture

Weekly expiration might be exacerbating the moves today http://bit.ly/h143ss

Fri, 01/28/2011 - 13:29 | Link to Comment bunkermeatheadp...
bunkermeatheadprogeny's picture

Feeling lucky, I just BTFD in FAS.

Fri, 01/28/2011 - 13:31 | Link to Comment gwar5
gwar5's picture

Yes, we have no bananas, and neither does the Fed.

Fri, 01/28/2011 - 13:37 | Link to Comment FLUSA.com
FLUSA.com's picture

time to go back to Tally Sticks????

Fri, 01/28/2011 - 13:32 | Link to Comment TruthInSunshine
TruthInSunshine's picture

The Ben Bernank is a silly man, with a quivering lip, nervous in speech and action, and the world's investors will witness the destruction and malinvestment of capital his dangerous policy actions have wrought.

Fri, 01/28/2011 - 13:32 | Link to Comment max2205
max2205's picture

tape just like 1 st trading day this month but in reverse....lots of -3% - 6% ers

red for the month 1260 on spx looks likely

Fri, 01/28/2011 - 13:33 | Link to Comment Oh regional Indian
Oh regional Indian's picture

I think a lot of money will come screeching into countries like India, where the public is newly enriched and ripe for the taking.

Other boats may well float too. Metals of course.

But the situation in North Africa has really thrown it all up.

Weatherman, wind direction?

ORI

http://aadivaahan.wordpress.com/2010/06/14/70/

 

Fri, 01/28/2011 - 13:36 | Link to Comment HUGE_Gamma
HUGE_Gamma's picture

yeeee for d trigger

Fri, 01/28/2011 - 13:37 | Link to Comment Seasmoke
Seasmoke's picture

its truly a BTFD kind of day

Fri, 01/28/2011 - 13:42 | Link to Comment bunkermeatheadp...
bunkermeatheadprogeny's picture

Market has hit bottom, hope everyone BTFD.

Definately a work through lunch day today.

Fri, 01/28/2011 - 13:59 | Link to Comment blackbox
blackbox's picture

this does not have the feel of the creeping previous falls.

there is good volume today - very surprising for a friday - and previous 'dips' have been bought quickly.

that's my take on it anyway. I'm not buying this dip.

bonne chance!

 

Fri, 01/28/2011 - 14:12 | Link to Comment TruthInSunshine
TruthInSunshine's picture

Baghdad Bernanke is 100% certain there is little or no inflation (deflation is the big risk, he says), that the economy is undergoing a true, V shaped recovery on fundamentals, and that Egypt is a stable democracy.

Fri, 01/28/2011 - 14:20 | Link to Comment SheepDog-One
SheepDog-One's picture

TOTALY stable in Egypt...meanwhile Clinton says theres no need to worry until we see full revolution riots in Yemen...and on cue heres breaking revolution riots in Yemen as well. Buy the fukin world implosion!

Fri, 01/28/2011 - 14:20 | Link to Comment slaughterer
slaughterer's picture

I am watching JPM buying the Russell on L3 right now.  They just need another hour or so, until we can go back up.

Fri, 01/28/2011 - 14:21 | Link to Comment SheepDog-One
SheepDog-One's picture

Good! Let em buy it all! JP Morgue bagholders and other the others, fuk em.

Fri, 01/28/2011 - 14:20 | Link to Comment cramers_tears
cramers_tears's picture

Where's "The F*#&%@$ BERNANK?"  Oh yeah, he's getting his Fri Rubdown.  He'll have this all straightened out by the closing bell - unless he starts drinking @ 2... then... STFT!  Wait for the dip next week, when "The Bernank" has sobered up from the weekend.

Fri, 01/28/2011 - 14:21 | Link to Comment Pat Hand
Pat Hand's picture

The reversal reversed this week.  Quants are way way up for Jan.  Doesn't mean that some quants aren't doing stupid things.

Last week's action was liquidity driven.  Probably someone reallocating or a style rotation; possibly someone liquidating a book.

Whatever it was, this week was hugely positive.

If it is anything like 2007, it's like July, not August.

Fri, 01/28/2011 - 14:25 | Link to Comment slaughterer
slaughterer's picture

I see it more like end of Feb 2007, not July 2007 or August 2007.

Fri, 01/28/2011 - 14:37 | Link to Comment Pat Hand
Pat Hand's picture

You might be right.  The cross-section of today's action is pretty benign.  All that's happening is just centered around a 2% delta, a lot like Feb 27, 2007 when China was down 9%, US down 3%, but cross sectionally indistinguishable from normal

Fri, 01/28/2011 - 15:15 | Link to Comment slaughterer
slaughterer's picture

I would agree with the "benign" diagnosis.  Alot of algo-traded small cap MOMO is trading oblivious to the major index moves and not suffering much damage... proportionally.  The correction has yet to hit the full cross-section.

Fri, 01/28/2011 - 14:45 | Link to Comment Bigger Dickus
Bigger Dickus's picture

Three words. AT FUCKING LAST.

The following video best explains how I feel today:

http://www.youtube.com/watch?v=q951qv7EbKs

Fri, 01/28/2011 - 17:08 | Link to Comment lilimarlene1
lilimarlene1's picture

Been reading your pain the last while. Maybe, instead of reading BTFD, people will start saying AFL in honor of you, BD.

 :)

Fri, 01/28/2011 - 16:44 | Link to Comment mkkby
mkkby's picture

I don't think this is a reaction to Egypt because the selloff started at 6:50 am NY time.  I think it is a reaction to the weak employment numbers yesterday.  All the hedgies bascially waited until after the open to start de-risking.

I don't think we BTFD until ES hits the 200 day moving average at around 1150.  Which is about 11% down, like Demark predicts.

 

 

Fri, 01/28/2011 - 20:17 | Link to Comment johngerard
johngerard's picture

agreed - egypt is just window dressing for this move.  minus 10%-12%.  then BTFD like a bastard.

Do NOT follow this link or you will be banned from the site!