Market Quants; Kill or Cure?

This brilliant VPRO documentary on Quants should be required viewing for all involved in markets.

The problem with heckling from the cheap seats is that the rest of the audience can get bored pretty quickly and stop listening. Then you get thrown out. It’s the old ‘cry wolf,’ thing. I kind of feel like that about shouting from my soapbox about quants and all they have spawned in markets from HFT’s, trading Algo’s, to derivative and structured product modelling. I’ve watched their growth from all the way back when index arb models lit the fire that turned into a market conflagration in 1987 to the subprime CDO models that did so much to destabalise the financial system in 08 through to the occasional flash crashes we see today.

The simple fact is that very few managers and certainly no boards have the first clue about what the quant ecosystem that plumbs their banks together is capable of. Nor do they understand the assumptions made in those models or how vulnerable the models are to human error or abuse, either internally or externally. The video clip above is very well worth watching. It is a very straight forward reality check; a reality check from the practitioners themselves; ‘it is clear that a major rethink is desperately required if the world is to avoid a mathematically led meltdown.’

Markets; Walking on Ice

You certainty do.....

An opportune time for a distraction into markets which despite looking firm optically are a lot more fragile and shaky beneath.

A poor start to the week then with the G20 joining the IMF and BIS with bubble warnings and of course TSCO which says it has uncovered a “serious” issue, is investigating and has suspended a number of staff; "Principally due to the accelerated recognition of commercial income and delayed accrual of costs". Yep, £250m is serious all right. Something the now suspended UK CEO can reflect on. The fact that small chocolate supplier Moo Free Chocolate had to threaten the firm with a winding up order to receive a payment more than three months overdue is a tell on the internal culture. Tesco is many things but from a market point of view its like a bank, you simply don’t know what is in there because clearly the management don’t. Today’s announcement does though, come after a long period of shall we say financial flair during which return on capital employed deteriorated while EPS increased. Terry Smiths article in the FT earlier this month gave a good précis.

 The Alibaba IPO came and went. Its market cap of $168bn at the offering price made it the 36th most valuable company in the world which clearly wasn’t enough for the market which pushed it up another 50%. Buyers don’t of course get shares in the company. Instead they receive units in a Cayman Islands holding company. It makes most of its money in China, lacks transparency and there is no lock up period for the $8bn worth of units that can be sold. Think I’ve heard enough.

Taper will begin to have a deleterious impact on markets; it has to. In effect, the Fed is draining liquidity with its massive position in securities issued by corporations and government. As issues mature and coupons are due, money will flow to the Fed from the issuers withdrawing money from the economy. It’s tightening in all but name and its not a great time for that to happen. The Fed delayed a cathartic clean out with QE but having kicked the can down the road we’re arriving at the spot where it landed. Velocity of money slowing and tighter lending are not what equities like to hear.

Hindenburg Omen back again to cheer us up

Market participants should be braced for more negative headlines and by now be positioned defensively. The market is in a fragile and precarious place. Thursdays first Hindenburg signal was confirmed with another on Friday. That means that we have a 25% probability of a crash in the next four months. In itself that’s something we can manage but with the timing coinciding with the negative divergence in the NYSE cumulative advance/decline line and the 23 year maturing Jaws of Death Megaphone Top pattern we have a confluence of indicators bearing down which ought to make us sit up and take notice.

On Friday, New Highs were 128 and New Lows 102, the lower being 3.14% above the 2.20% threshold. New highs were not more than twice new lows, the McClellan Oscillator was negative and the 50 day moving average was higher than it was 10 weeks ago. With the exception of the mini crash of summer 2011, a HO has been present in every crash for the past 27 years but there hasn’t been a crash every time a HO signal has appeared.

 The divergence in the NYSE Cumulative Advance Decline Line started at the beginning of the month and is moving rapidly. The depth is similar to that last seen in 2007.  We also see negative divergence in the Russell and NASDAQ 10 day moving average Advance/Decline Line.

 Despite the record high close in the Dow on Friday decliners outnumbered advancers with a ratio of 1.4:1. As we discussed last week, many parts of the stock market hit highs months and months ago and have been in decline since. Yet we continue to see headlines typical of euphoric phases such as those alluding to luxury goods, residential and commercial property, art and tech. That the Russell 2000 is at a 22 month low ought to be a concern for investors. UK small caps are in a better place but for how long I wouldn’t like to speculate.

The original expectation of a 5-10% correction is still good but these other developments are telling us that while equities may look good optically, in fact market psychology beneath the surface is quickly turning negative. The expected correction could surprise to the downside.

The SKEW Index which we discussed on Friday closed at 146.08; that’s the highest reading since 1989. This index indicates that option traders are pricing in a near record probability of a large move in the next month.

European equities will also reverse this week. Quite simply, take nothing at face value; equities are displaying multiple exhaustion signs and are walking on ice.

Commodities meanwhile are not making life easy for anyone. On the one hand, multiple commodities are at multiyear support points; on the other the broad based commodity indexes are not a picture of health and vitality. At some point liquidity will flow from equities into the commodity complex but right now they are signalling deflation. If these already oversold assets are hit hard again there is a pretty simple message for equities there.

Gold, silver, Euro and Sfr all on support lines going back to the early 2000’s.

…. And the converse of those is the USD which is back at long term resistance and where bullish sentiment is plentiful.

Crude is back to 5 year support which really needs to hold.  It could drop rather a long way if it fails. Oil is probably waiting for the dollar to top but the rest of the commodity complex is unlikely to get a lift unless oil is leading.

Gold bulls need to be prepared. If they're not yet in the bunker they should be.

This week could be a bad one for precious metals. Fasten seat belts and cross check. Gold is sinking into its capitulation phase. It’s taken a while. I first decribed this in a piece called “Panic and Opportunity,” back in April. “A failure there, ($1280), will demoralise gold bulls but it will portend a more significant fall to the Dec low at $1180 with a possibility of the $1050’s beyond. A collapse to those levels would obliterate sentiment, create forced sellers and create the conditionality required for a final bear market cathartic cleansing thereby forming a firm base from which to move into a multi year bull market. That point of maximum pain will be the point of maximum opportunity but it will feel gut wrenching to pull the trigger when everyone else is racing round with their pants on their head.” Not much to add to that.

We can expect a reasonable bounce from daily cycle lows in the precious metals but most rallies will be met with more selling. We need to get through the cathartic washout to create the foundation for a long term rally.

In summary then, we’re about to see the kind of volatility usually associated with  the second half of September. Nothing unusual there but given the fragility of markets which has been largely ignored by the media surprise moves, and risk, therefore lie to the downside.

Outrage, disappointment and defeated resignation

Disaster on the 05:57hrs from Petersfield this morning as outrage, disappointment and defeated resignation rippled through the ten carriage train as the early wave of City bound commuters learned from Pat, OC the Tea Trolley, that, “sorry, no teabags; they forgot to load the teabags.” There is nothing guaranteed to more upset the dutiful equilibrium of the early morning commuter than no tea on the tea trolley. No tea trolley at all would be better than watching the approach of the trolley with quiet satisfaction, knowing that a hot brew is moments away, only to be thwarted by sloppy loading at the depot. This is the sort of lost nail that can lead to the loss of a pretty important horse.  Were markets to crash later today, the cause may not be the US GDP or the FOMC statement falling short of market expectations but rather the lingering sense of disbelief and hopelessness of the CIO’s, fund managers and traders on the 05:57hrs from Petersfield.

Markets; Headwinds Abound

The papers abound with upbeat copy about UK growth and politicians are scrambling over each other to claim participation and responsibility.  Growth though, is anemic and there are substantial headwinds out there for investors. Many of those investors are very probably, and rightly, just getting on with their lives. It's time though, to join the Wide Awake Club. 

Markets will ebb and flow but structurally, they are weakening. The equity bull is anyway, growing mature and is into the normal timing zone for a cyclical bear mark to take hold. The coming months will be very choppy and conservative investors, widows and orphans should be extremely cautious and focus on capital preservation, not media headlines.

One man who has a good handle on events is Grant Williams, the author of the newsletter "Things That Make You Go Hmmmm." In this well worth reading piece he takes a look at some of those September headwinds.

Any passing reader for whom the whole financial press reads like something written by a mad Aramaic monk may wish to brief themselves with this video, also by Grant which, although a few months old, represents a good briefing on what has gone wrong in the past and how financial recovery may be nothing more than a mirage with the crisis about to intensify, once again.

 

If it leaves you slightly concerned.... it should; I am.  We're not quite at Defcon 1, Tin Helmet time but it's closing in.