Between macro-economic 'religious' experiences, regulatory uncertainty, and legislative gyrations, the world appears to be a very different place now than before 2008. It seems that from the 'Lehman' moment (some might call it an 'epiphany' moment), and later the US downgrade, markets realized that the impossible was possible and while every long-only manager will try to convince you that nothing has changed, these four charts (via Barclays) will go a long way to proving that everything has changed. Whether it is policy uncertainty, the frequency of 'fat-tailed' events, market illiquidity, or the domination of correlated 'macro' risk over idiosyncratic diversification; trading (or investing) has profoundly changed since 2008.
1) Regulatory/Legislative Uncertainty has experienced a regime shift.
Current issues include:
- Markets continue to be affected by the uncertainty surrounding the implementation of Dodd-Frank
- In addition, there continues to be overhang from the Supreme Court review of the 2010 federal healthcare law. A decision is expected Thursday
- The uncertain outcome of the fall presidential and congressional elections, and the potential implications for legislative policy and the fiscal cliff will also begin to affect markets as we head closer to the election
2) Fat-Tails Are Fatter
Any policy/macro developments today have a more profound impact on risk assets than in the past.
3) Rising Systemic Correlation Has Caused Macro-Risk To Dominate Investing
Macro Forecasting vs "Stock Picking"
- With heightened policy uncertainty and the prospects for a resolution to Europe driving markets, the past year has had, comparatively, the smallest opportunity set for single-name trades versus macro trades in the past 15 years
- We believe this trend will continue throughout 2012 as broad concerns about European sovereigns/banking system, a global growth slowdown, and the US presidential elections dominate the investment decision process
4) Markets Have Become Notably Less Liquid
Fewer Participants, Less Liquidity
- Dealers have shuttered their prop desks as a result of increased regulation
- Hedge fund participants, especially those engage in correlation trading, have declined
- With fewer participants and new entrants in the market, there are fewer cross currents and opportunities for price discovery
- Market participants who were prolific sellers of protection prior to the crisis either no longer exist or are no longer actively engaged in the CDS market
- The lack of prolific sellers of credit protection has made it more difficult for dealers to hedge and has consequently contributed to lower levels of dealer inventory
Change indeed - maybe this time it really is different