Exchange Traded Fund

The Top 10 Reasons For Surging Asset Correlations

"Wax on, Wax off", "risk on, risk off", whatever you want to call it, the most prevalent phenomenon in capital markets over the bear market rally of the past year has been the gradual yet relentless rise in cross asset correlations. As we reported earlier, hedge funds are now openly returning capital due to their inability to properly hedge positions and execute on traditional long/short strategies, which in turn is wreaking havoc on the entire 130/30 or 130/70 model (which also means gross leverage for most rational hedge funds is reduced as those who do gross up, are effectively betting the farm on market moves with an increasingly shorter and more volatile even horizon). Long before this became a daily topic on CNBC, we were warning about the dire implications of alpha extinction, and the impact it would have on hedge funds. And with the opportunity to diversify away risk increasingly taken away from investors, we expect that this trend will result in ever more capital fleeing the stock market. Yet the question remains: what has caused correlations to surge to current levels? If these reasons can be identified, it should be easy to eliminate them one at a time until some semblance of a rational market returns (at least on paper). Luckily, Nicholas Colas of BNY has once again beaten us to the punch, and has compiled a list of the top 10 reasons for increased asset price correlations. So without further ado...

Why Record Stock Correlations Are An Adverse Feedback Loop To Market Participation

The ongoing retail abandonment of stocks is well into record territory, which may occur for any of a variety of reasons (need for cash via redemptions, focus on return of capital than on and shift into fixed income, market distrust, etc.), yet the resulting increasing relative participation by electronic feedback loop chasers and by beta levered players, and the subsequent increase in implied and absolute stock correlations may be a vicious circle that will make future retail participation increasingly more difficult. We have been warning about the threat of lack of stock diversification for many months, although have not been able to explain it as succinctly as BNY's Nicholas Colas succeeds in a recent note, titled "Looking for diversification in all the wrong places", in which he concludes: "If you cannot use diversification to manage incremental risk, then why would you take on risk in the first place?" This hits the nail on the head in terms of the ongoing and future lack of stock inflows, since in simple terms in makes the ever greater correlations between various asset classes a barrier to entry for all those very rational investors who seek to diversify bullish or bearish bets with a matched trade. In other words, the market is receptive only to those who blindly wish to bet it all on black or red (with or without leverage). And with ever more people chasing ultra short term return horizons (think numerous underperforming hedge funds that only have one month left to generate some returns in Q3 before their LPs send in the redemption notices), and placing all their bets on just one side of the line, those who wish to pursue rational trades, and generic long-short funds, increasingly obsolete and redundant. All in all, this is a perfect storm for a feedback loop that selects only for those who are willing to bet on an ever more one-sided, and thus unstable, market. Have we gotten to the point where only another market crash will provide retail with suitable speculative entry points?

madhedgefundtrader's picture

Retail investors are getting fleeced when playing the agricultural and commodities ETF’s. A harsh lesson about contangos. An entire sub industry of hedge funds has arisen to take advantage of this spread, at the expense of the ETF investor. Morgan Stanley is now chartering more tankers to take delivery of crude than Chevron. Gaming the published “roll dates.”

Guest Post: GLD And SLV: Disclosure In The Precious Metals Puzzle Palace

This article was inspired by a conversation in January 2010 with fellow directors of the Gold Anti-Trust Action Committee: Chairman Bill Murphy, Secretary/Treasurer Chris Powell, and Directors Adrian Douglas and Ed Steer. In speaking about the growing role of the exchange traded funds in the precious metals market, it was clear that the disclosure that the precious metals ETFs described below were providing to investors was inadequate. However, was there a material omission under securities law? I found the issues complex. Understanding the commodities markets can seem daunting to someone like myself with a securities background. Meanwhile, the securities markets and related legal and regulatory issues can be unfamiliar to those with a background in commodities. I decided to ask my attorney to help me gather the relevant information into one document to make it easier for GATA supporters and other interested parties—whether from the commodities or securities markets—to examine these issues and to better understand and price these securities. - Catherine Austin Fitts, Solari Report

Guest Post: Technical Setups On Gold, Silver, Oil & Natural Gas ETF’s

This week has been playing out as expected with prices grinding their way higher and lots of sharp intraday sell offs and rallies which is indicative of a market getting toppy.

Seems like the masses feel as though they are getting left behind which is why we are starting to see the panic buying in the market (new money buying at these lofty overbought prices).

Each time there is a new intraday or daily high on the major indexes there is a renewed bullishness created as breakout traders and novice traders buy into the market hoping for the next surge in price. It is these volume surges of new money entering the market which the big guys (smart money) are selling into. You can see it clear as day light on the intraday charts as new money gets sucked into the market new high and then 2 minutes later larger waves of selling hit the bids.

Let The Churn In QQQQ, Citi And Bank of America Hit Infinity: ISE To Offer Special Rebates For Liquidity Providers In These Three Names

Today, one quarter of the volume in the market is attributable to trading in Citi shares. This is simply a ridiculous statistic, and shows that the broader equity market, which merely trades based on the momentum of one stock, is and has been busted for about a year, when we first wrote about this phenomenon. Yet this insane churn is not enough for some: The ISE has just announced it is introducing a "Modified Maker/Taker Fee Schedule" for the three most actively traded options products on its exchange: QQQQ, C, and BAC. In essence, the ISE will provide even greater rebates to "liquidity providers" in these three stocks. The entire market will soon consists of exactly two companies (both of which are wards of the state) and one ETF, as liquidity finds the path of least resistance and greatest (evaporating) profit margins. This is what "liquidity" in the market has become. And all the while, the latest DMM, GETCO, which is certainly not frontrunning its prop positions based on massive NYSE flow traffic, is laughing all the way to the bank.

asiablues's picture

New York crude has been trading in the $69-$83 range since late September as uncertainty over the global economy has contributed to several failed rallies. The close above $81 last Friday sparked speculation that oil could be targeting $85 in the near term. Now, some traders and analysts say currency movements may play an important role in pushing prices beyond those limits.... or will they?