CASTrader Blog

Quant "Bloodbath" - The continuation

For what it's worth, the same stocks I noted as having unusual price action last Thursday are having the same action today.  Some of these stocks are up 9% in a down market, just like they were last Thursday.  Are quant funds still unwinding?  It looks suspicious to me, albeit less pronounced (so far).  (Update: London hedge fund liquidating?  Hard to say if this is rumor or joke.)  (Update III: Moody's warns of potential major hedge fund collapse).

Update II from a Jon Markman article (emphasis mine):

He believes that gigantic funds focused on statistical arbitrage, such as ones run by Barclays Global Investors, quietly became the biggest owners of small-cap value stocks in the past couple of years and are now in the process of dumping them wholesale in response to unexpected performance troubles. Once the mass selling is complete, which he expects will be by the end of September, he thinks the market will catch its breath and re-evaluate the prospects of individual companies again.

From around the web:

The Wall Street Journal compiles hedge fund "Dear Investor" letters, with commentary by DealBreaker and by COTSTimer.

Merle Hazard's "H-E-D-G-E" music video via footnoted.

From market makers to volatility makers.

Rick Bookstaber on creating a differentiated hedge fund product. (Update: but is differentiation even possible?)

The Aleph Blog has a good roundup.

Leverage beyond your means at Goldman for a "25 standard deviation event", but the fees are now free.

What happened when we had a credit crunch in 1966 or 1970?

Quant Fund 'Bloodbath' - the aftermath

Is it over?  It was a wild day, beginning with "mega-turnover," but stocks that I previously noted as having irrational behavior seemed to change course almost at the open today.  Stocks that were zooming up zoomed down and vice-versa.  Perhaps it was the money transfusion (more on that here), or perhaps bargain hunters swooped in.  If these stocks are indicators of the bloodbath, then the quant funds got a substantial reprieve today.

Renaissance takes a hit. via 1440 Wall Street: Super Quant Jim Simons' Renaissance Tech reported an 8.7% loss on his $25B Institutional Equity Fund (Video) today, confirming earlier rumors (the text of Simon's letter here).  A 45-year look-back model suddenly went "out of whack over the first six days of August," according to David Faber.  There's speculation on the video that other traders "cracked the code" at Rennaissance and exacerbated the problems.  There's no confirmation I can find that SAC Capital was "running algorithms in reverse,"  but I agree it makes perfect sense.

Other tidbits:

Man Group shares slump on AHL Quant Fund redemption fear and delays it's historic hedge fund IPO (more here).

World Beta provides some evidence of both long and short portfolios he tracks both losing value.

Goldman Sach's Global Alpha is (was) apparently down 26% for the year (more on this rumor) and closes it's North American Equity Opportunities Fund and rescues Game Group which was rumored to be impacted by long/short fund liquidations at Citadel, according to the link.

Whether the bloodletting is over or not, one thing is for sure, redemptions are looming and the impacts of losses will be felt.

Quant fund 'blood bath' update

As the "worse than LTCM" credit crunch continues, new details about the quant hedge fund bloodbath that I discussed in the previous post have emerged.  Ironically, the LTCM "trio" recently reunited to form a quant fund.  First, a theory of what's going on (emphasis mine):

To stem possible losses, the managers sought to scale back their leverage. But selling the illiquid credit products risks uncovering even deeper losses as the credit positions were marked-to-market instead of marked-to-model, so these managers likely de-levered by selling more liquid assets—namely, US stocks.

“As these managers unwound significant factor based portfolios, these factors started to behave in unexpected and potentially troubling ways. Short names started to rally and long names started to fall as these trades started to hit the market. As most quantitative managers use similar quantitative factors, this abnormal factor phenomenon was not confined to a few funds. Rather, a large number of quantitative managers have seen their models begin to behave in unexpected ways. Again, it is no longer only the multi-strategy managers, but now pure quantitative equity managers who have started to see their portfolios ‘misbehave,’ both U.S. domestic and global fund managers,” explains Lehman Brothers analyst Matthew Rothman in a memorandum published today.

Now rumors are flying (via Scurvon Investing), including that Super Quant DE Shaw is down (update) and Jim Simons' fund is affected; and SAC Capital is "running algorithms in reverse" to profit.  More rumors: a second Goldman Sachs fund is unwinding.  Meanwhile, confusion reigns.  Update: yet more rumors.

Tykhe Capital (founded by DE Shaw refugees) is apparently down 20% in August alone.  (Update:  Tykhe goes on record to say losses are between 17% and 31% in August).  Black Mesa is (was) apparently largely in cash now sitting on the sidelines, afraid of a spiral of 'me-too' liquidations.

Bruce Chadwick has more:

I have several friends who manage quantitative portfolios across a range of asset classes, and they have pretty much *all* been having a very difficult time over the past few weeks as the subprime mortgage crisis provokes a crisis of leverage and in turn provokes a liquidity crisis which then provokes an asset crisis.

...

The remarkable thing about the present situation is how small the real trouble in the subprime market sector really is, and yet how large an effect it is having.

...

The problem is - what to do when there is a major contraction of liquidity and computers in charge of substantial sums need to sell and cover positions. If the quantitative models are similar enough, then the computers from a number of funds are all likely to be instructing traders to be buying and selling the same sets of securities.

I suppose the good news is that during a "quant fund crisis," stocks are likely being bought and short covered in equal amounts.  (Update: even some shorts are losing money).  A market neutral hedge fund unwind would be expected to create a relatively market neutral but volatile crash.  Perhaps it's already over.  Then again, one wonders: who's next?  For all the hoopla and hysteria and the hedge fund implode-o-meter (via Prudent Investor), this still isn't even a 10% correction in stocks.  Perhaps today will tell the tale:

Russell is intensely jumpy. But Thursday night he wrote that the Dow Theory sell signal had not been confirmed: "The good news: the July lows are still intact and the new lows are contracting. The bad news Selling Pressure is rising to new highs, and an increasing number of people want "OUT" of this market. Tomorrow is Friday, and by tomorrow's close we'll see how many traders are willing to hold stocks over the weekend. Fridays are always significant in rotten markets."

Update: "Perfect Storm" for quant funds.  FINTAG is on top of the news.

Mahalanobis has more on the ins and outs of stat arb.

“As these managers unwound significant factor based portfolios, these factors started to behave in unexpected and potentially troubling ways. Short names started to rally and long names started to fall as these trades started to hit the market. As most quantitative managers use similar quantitative factors, this abnormal factor phenomenon was not confined to a few funds. Rather, a large number of quantitative managers have seen their models begin to behave in unexpected ways. Again, it is no longer only the multi-strategy managers, but now pure quantitative equity managers who have started to see their portfolios ‘misbehave,’ both U.S. domestic and global fund managers,” explains Lehman Brothers analyst Matthew Rothman in a memorandum published today.

Financial Engineering: USA v. Asia

China/Asia may be gutting the US manufacturing sector, but when it comes to money, a few recent items indicate there's more than a few dollars flowing the other way:

Alea highlights a very interesting article regarding leading US investment banks and the sub-prime fiasco.  In what appears to be a brilliant on-the-fly move, they anticipated the crunch and created a new derivative to hedge their exposure.  The article indicates they may actually make a bundle off it.  Who's on the losing end?  Asia and Europe.  Some European banks appear to be on the winning end.

Not off to a good start, buying at what has been called the Blackstone Peak:  China's overseas investment fund's first investment was in the Blackstone IPO and gets clobbered, sparking anger in China.  Blackstone chart.

China threatens the nuclear option to sell dollars.  It seems to me like this would hurt China more than the US, but no doubt US investment banks will be hedged.  Other Asian tigers may feel compelled to buy dollars.

Of course, there's always seigniorage and the benefits of being a reserve currency.

The money flow is by no means one-way.

Still Booming (and hedging)

Still Booming. I'm still getting hammered by other projects such as one involving the dam at left.  Inbetween these, I'm taking some breaks for much needed RnR such as mountain biking.  It's really become apparent how much the energy boom in oil country is starting to impact all sorts of things unrelated to energy.  It's also apparent from my perspective that to the degree energy prices stay as high as they are (update: Energy Blowoff?), they will begin to spread this persistent component of inflation around.  It's not just that the cost of energy that gets passed around - attraction of skilled people by energy companies to help exploit the boom mean that other industries are going to be hit with labor shortages and higher labor costs.  Since energy employs a diverse skillset that overlaps other unrelated industries, the impacts can be felt relatively far and wide, at least around oil country.  Despite the apparent housing crash, home prices in certain parts of oil country as far as I've seen are booming.  A substantial portion of the economy is switching to the exploration and production of energy and/or alternative sources.  Business plans are being written as we speak to divert yet more resources to take advantage of the need for energy.  These are jobs and costs that can't really be reduced by outsourcing to China and India and are dependent only on the price of energy.  Coupled with persistent high commodity prices, I think the impacts will continue to filter through the economy. (Update: CXO Advisory discusses an interesting paper on energy inflation and the Federal Reserve).

Hedging.  During my hiatus from blogging, I began scaling into a hedge on the market by selling LEAP calls against the general market.  Having generally been long the markets since Summer, 2003, so this is a significant change for me.  I am keeping my longs, and essentially setting up a buy-write position on the market, even though my long stocks and my Shannon trading strategy don't entirely mimic the underlying market.  Fortunately, I scaled in and sold 2/3 of the options before the recent market hiccup.  Unfortunately, I missed selling the other 1/3 and am loathe to do so now.  My reason for hedging wasn't that I necessarily believe the bearish scenarios (link via The Big Picture), rather, it was that I was highly skeptical that the market could advance far enough that the options would lose more than the collected premium.  It's a portfolio optimized for a generally sideways, slightly up or down stock market rather than a zooming or plunging one.  To the extent the market is volatile as well, I'll be a happy investor because the Shannon strategy will harvest volatility profits.

CASTrader.  None of the above has anything to do with CASTrader, of course, but in the near future, I'll hopefully be back to somewhat regular posting.

 

Boomtimes

In my other life apart from developing CASTrader, I sometimes consult on projects where slope stability and landslides are an issue. Such is the case the past few weeks as I am involved in the construction of a new gas well stuck high up on a cliff in a landslide area. The oil and gas boom has created a lot of activity around the Piceance Creek Basin (PDF), a portion of the home of more potential oil than Saudi Arabia (if you can get it out). Oil and gas companies seem to be drilling anywhere and everywhere. Around the town of Parachute, where I'm staying, motels are 100% full of all sorts of contractors - the place is hopping with activity. Property values are way up, along with everyone's salaries.  Local word is it's pretty easy to earn $100,000+ if you have what they want and are willing to work.  It's not quite the wild west atmosphere of the previous energy boom when inflation-adjusted oil was these levels and oil shale projects were red hot, but it certainly reminds me of that period.

Just the fact that about everyone with a pulse who has any know-how at all is being wooed to lend a hand makes me wonder if oil is peaking in price rather than quantity produced. The history sure is rhyming. I made a friendly bet with someone about a year ago that oil would not hit $100 before 2010 just as it was zooming past $80, as I felt is was soon to peak or at least plateau. Seeing this boom first-hand, one gets a healthy respect for it.

At night, the Colorado River valley between Newcastle and Parachute is lit up with the activity of several dozens of drilling rigs. Assuming the well I am working on is a producer, it will be online in a matter of months, like so many of the other wells being drilled. Such is the case with current energy prices that have set off a boom the likes of which have not been seen in 30 years. Although there's certainly counterparts to these wells that are seeing production declines, at least in this little corner of the world, new supply is far outstripping decline.

It's certainly nice to get out in the wilds a bit, and while I've had some good photographic opportunities of peaks, plateaus and canyons (the view from my work area is at left), I haven't done much with CASTrader.  It's been far easier to get out exploring the surrounding area at night after work, collecting a few scrapes, bruises, sore legs and photos along the way than code CASTrader.   That will change when this well pad is done in the next few days, at least until the next offer I can't refuse comes along. Until then, here are a few photos I've taken of the surrounding country.

Update:  Brett Steenbarger covers the geopolitics of oil, particularly in Iraq, which could definately impact the price of oil.