This was quite an exciting week, where at one point the S&P erased it’s gains for the year but ended this week up finishing up +1.68%. Will these +/-2% daily moves continue, and pick a direction? Are people keeping their positions, or reallocating? Stay Tuned.
Stock Market Commentary:
It is TOO Late to Sell and It’s NEVER Too Later to Sell…and ROBO Advisor Advice – The Market Panic of 2014. – (Howard Lindzon)
Omaha, Process, & Skin in the Game – (Meb Faber)
When To Pay Attention To The Stock Market (And When To Ignore It) – (Five Thirty Eight)
5 Thoughts on the Stock Market’s -7.5% Correction – (Attain Alternatives Blog)
Chicago and the Market Movement:
CBOE Futures Exchange sees Busiest week in History – (HedgeWeek)
Why the stock market’s scary ride is a win for Chicago exchanges – (Crains Chicago)
Cliff Asness says market volatility is a good reason to diversify – (Investments News)
Under the Hood: Wisdom Tree’s Managed Futures ETF – (Attain’s Alternatives Blog)
Countries that suffer when the oil price plummets – (The Economist)
Preqin Quarterly Update Q3 – (Preqin)
Want to feel better about Ebola? This (massive) chart should do the trick. – (The Washington Post)
Just for Fun:
Hawk attacks drone: Video captures red-tailed hawk attacking drone – (NBC)
Photos: 50 Chicago sports teams that no longer exist – (The Chicago Tribune)
Does Chicago need express train service to O’Hare? – (Redeye)
Guy In Alaska Skips Rocks On A Frozen Lake, Has Mind Blown By ‘Coolest Sound Ever’ – (Huffington Post)
Think the Kansas City Royals Are Named for Kings? That’s a Bunch of Bull – (The Wall Street Journal)
The Playoff Implications Of Every Game For Every NFL Team – (Five Thirty Eight)
- Why is ANYONE surprised?
This has been the most hated rally of all time, as quoted by Barry Ritholtz, The Wall Street Journal, and CNBC; with seemingly many more people doubting its ability to survive than actually participating. What’s more, this thing was getting very long in the tooth – 68 months and 197% off the March 2009 lows as The middle of September, and 17 months since the credit crisis losses were erased with a new all time high in March 2013. Compare that with an average bull market move of 103% and 30 months off the lows, and 18% and 14 months from new highs to the eventual peak, and you can see we were due. It’s also worth noting we’re basically flat on the year after this “correction”… no gains, no losses. While hard to believe after the past few years – the stock market does have losing years. Let’s repeat that: In distant times (like ancient 2011), there were entire 12 month periods where stocks didn’t end higher than they started a whole year ago… Quelle Horreur!
- Short Bonds if you dare…
We’ve also been due for interest rates to rise, and a lot of smart people have bet a lot of money on that happening (including one Bill Gross, whose wrongness there no doubt led to his eventual exit from Pimco). But this is the new widowmaker trade. They are carrying people out in bodybags from this one, as every head fake lower in bonds results in violent upswings. Despite us being 6 years past the credit crisis – when everyone though rates would be going back up by now, 30 yr US Bonds have dropped from around 4% to nearly 3% this year, with bond futures prices shooting up about 7.5% in the past 20 trading sessions. There’s some programs killing it on this trade, but there’s also a lot of pain and debris left over from bonds once again moving higher (rates lower).
- Managed Futures have been waiting for this…
September was great for managed futures, and we’ve been cheering stocks to zero so far in October, because this type of environment is what managed futures lives for. It’s been a quiet few years of waiting for a volatility expansion like this for managed futures strategies, most of which essentially bet on outlier moves like this one happening, not just in stocks, but in bonds and currencies, and the rest. The ability to be able to go long and short – combined with the ability to be in markets like bonds, wheat, and even stock indices – means these types of moves can be captured. Now, there are likely to be whipsaws and the potential for lower volatility ahead… just like the stock market, volatility can’t keep rising day after day; but every manager we talk to is very excited about this new market environment.
- This is why you diversify…
If this type of market move scares you – remember this is why you diversify; even when that strategy has been getting it’s ass kicked the last 5 years. Those who are diverisified and missed out getting the full return delivered by stocks the past few years realized that diversification isn’t in place for what is going on today, but for what may come tomorrow (tomorrow is here). They realized that the choice to diversify can mean accepting smaller positive returns today in return for smaller negative returns tomorrow. At the end of the day – this isn’t just about the final return – it is about the journey as well. It’s about avoiding the swamps… as the Abraham Lincoln quote in the movie Lincoln illustrates:
“A compass, I learnt when I was surveying, it’ll… it’ll point you True North from where you’re standing, but it’s got no advice about the swamps and dessert and chasm that you’ll encounter along the way. If in pursuit of your destination, you plunge ahead, heedless of obstacles, and achieve nothing more than to sink in a swamp… What’s the use of knowing True North?”
Just owning stocks and hoping the market goes up indefinitely is akin to just plowing straight ahead with your Compass pointing North. We’ve landed in stock market swamp… You going to go through it, or diversify your way around it?
- This is proving time for Liquid Alts
There’s been a huge influx of mutual funds offering hedge fund like strategies such as long/short equity and market neutral, as well as managed futures mutual funds and ETFs that have come to market since 2008. This is the first real proving ground for those products, and the volatility and stock market losses should really start to separate the proverbial wheat from the chaff. It will be quite interesting to see who delivered on their glossy brochure promises and who didn’t when the dust settles.
One of the best things about being in an investment which can do well when markets are down is the fun you can have at cocktail parties, in the locker room at the golf club, and dinner with friends. A -334 point down day in the Dow and around -5% move off of all time highs starts to bring out the shrugs and exasperated expressions, as those well to do’s around you murmur their version of the timeless classic:
“Tough day in the markets today, huh?”
And here’s where it gets fun… because our go-to response is usually:
“Sure was tough… we hope they go to zero.”
For those from the world of traditional investing, or better yet – those who’ve only been around the last five years – this can be a bit unsettling and cuts a lot of conversations short.
“Go to zero? What?”
While we don’t actually want market to go all the way to zero (we still want a functioning society and all of that), we welcome with open arms the volatility that would accompany some fear and panicked selling. Because, you see, we’re mostly in the business of volatility. Or to be more precise – the business of profiting off of volatility expansions from periods of consolidation and dampened volatility.
As we have laid out before, managed futures tends to do well during market crisis periods because of their ability to go short global markets. In 2008, managed futures programs found themselves short nearly every type of market not considered a safe haven, be it stock indices, energies, foreign currencies, metals, grains, or softs. Fast forward to the past few weeks, and we’ve seen several managed futures programs start to initiate such short positions in markets like US and non-US stock indices, energies, foreign currencies, grains, and metals.
Quite simply, we’re cheering the markets to zero because the lower they go in this move down, the better for our clients in their long volatility investments. Of course, past performance is not necessarily indicative of future results and there are clients and programs and positions which may lose money in an extended move lower. But generally speaking, such down trends work to the benefit of the managed futures space in our experience.
So for now we’ll be cheering… “Go to Zero!”
(Disclaimer: Past performance is not necessarily indicative of future results)
Chart via Finviz.com
Part of the reason many believe social media will never die, is because of days like today. Stocks experienced their single worst day of the year. The Dow plunged 300 points (-1.97%), The S&P had it’s best day of the year yesterday, followed by it’s worst day in six months (down -1.98%), and social media exploded with posts, comments, and charts trying to explain just what was happening – as if we had just lived in a dream land where stocks only went up the past five years. Is volatility in stocks here to stay? Why did stocks gain 2% yesterday, and lose all of it the very next day? Is this another 2008? Are we all F*(^% crazy as Reformed Broker says.
First, some funny ones…
I’m confused… Is the lighting crushing something? Is the Lightning stocks? Or is it the Tornado? Is the Tornado volatility?
Knew we had seen this market action somewhere before… http://t.co/38vLSH3r8f
— Attain Capital (@AttainCapital) October 9, 2014
And some serious ones…
Picture Courtesy: CNBC
The obligatory serious looking trader guys… (is that guy on the right wearing a Flyers shirt… what trading floor is that?)
Chart Courtesy: Reformed Broker
Chart Courtesy: CNBC
Chart Courtesy: Ryan Detrick
We couldn’t resist this Bloomberg headline the other day: “Classic Cars, Lean Hogs and Duchamp Art Lead Alternative Investment Ranking” Cars, Hogs, and art… and an alternative investment ranking – this was going to be interesting.
Except the ranking is little more than the trailing 36 month returns – without mention of the volatility, drawdowns, or any other risk to the investments. And the so called “Alternatives” in the article seems to be an odd mish mash of returns for whole investment categories like Private Equity with its 100s of Billions of Dollars invested alongside the returns for single stamps from 1867 which gos for around $400.
Throw in a few Ferraris, REIT indices, some Bordeaux wine, Soybean Meal futures, and Hedge Funds; and it’s like Bloomberg vomited alternatives all over the page.
(Disclaimer: Past performance is not necessarily indicative of future results)
Tables Courtesy: Bloomberg
Now we get it, looking at exotic property or ideas is a lot more fun to read about then say risk adjusted ratios (what real alternatives folk geek out over), but to compare investing in wine and fast cars to Private Equity and Hedge Funds seems a bit off the mark to us. For one, there is perhaps $1 Billion worth of capacity in some of the ‘exotic’ investments put up on the page, while some of the hedge funds listed manage many billions. It’s not quite fair to compare the return on a $400 stamp or $1,000 bottle of wine with the Trillions invested in the hedge fund and private equity space. One is attainable to a handful of people in the world, the other to millions. It’s sort of like comparing the Yankees win/loss record for the year with Phil “The Power” Taylor’s darts record.
Oh well… the tables are pretty and it’s fun to see how much some of those ‘exotics’ returned. Who knew? Self storage REITs were the place to be. We’ll take the ‘under’ on that happening over the next three years.
As for their line about alternative investment (now they’re talking the whole world of them…) underperforming the S&P – that is another case of apples and oranges, although not for the reasons outlined above, with both return streams available to the masses. Alternatives are oranges to stocks apples because “Hedge Funds Don’t Care if They’re Underperforming the S&P.”
We’ve been known to help straighten out some wayward journalists from time to time, and our friend Michael Covel pointed out just such a journalist in need of some help last night via twitter:
— Michael Covel (@Covel) August 5, 2014
Now, Michael could be accused of drinking the trend following Kool-Aid a little too much at times, but there’s worse things to be passionate about, that’s for sure. And we don’t think Noah Smith is actually attacking ‘trend following’, despite the article’s headline and conclusion that “the trend is your friend till the bend at the end.”
Mr. Smith appears to be warning investors from taking on hidden risks in exchange for consistent gains, and cautioning against chasing performance. Mr. Smith appears to be telling investors in his ‘Investing’ column on Bloomberg View – to steer clear of the selling deep out of the money options. He is teaching us not to fall for the put-option fallacy, where investors get lulled into a false sense of security right before things blow up. He trots out examples of this fallacy in the mortgage backed securities bust in 2007, hedge funds in the 1990s and early 2000s, and Japanese workers (??).
The rub for Covel and ourselves is… He is warning against selling volatility. He is warning against booking small, consistent gains in return for the possibility of large future losses. But he conflates those warnings with “Trend Following,” seemingly not aware that Trend Following does the reverse. Trend Following is a LONG volatility strategy, which books small, frequent losses in exchange for the possibility of large future gains. It is quite literally the exact opposite of what is described in Noah Smith’s article.
The proof is in the past three years. The proof is in 2007 and 2008. If trend following were falling for the put-option fallacy – the returns would be a LOT better the past three years, but it’s been a skinny few years for trend following. See here, here, or here. Those selling volatility (ignoring the big risks of the past) are the ones making money, as can be seen in the short VIX ETF (XIV) or plain old $SPY. And what about 2008? What about when the hidden risks came flying to the forefront? How do you explain Trend Following’s outperformance during that time, Noah?
We suggest taking a short trip through a few blog posts and our educational materials on Trend Following, and maybe reading one or two of Covel’s excellent books on the subject, maybe rewriting the article.
– ‘Trend Following’ whitepaper
– Covel’s Books:
– Our series on how a trend following trade works:
Until then, on behalf of all the trend followers out there, we’ll echo Michael Covel’s sentiment.
“Please get a clue.”