We are slowly approaching the brick wall known as the trendline that was support for most of Jan and Feb. I still expect this line to hold and expect us to have a sizeable retrace from here.
The blogs have been full of stories regarding dark clouds on the horizon. Nothing you read in a blog can be considered the concrete truth unless it can be backed up with fact. Usually the stories have links to stories from reputable news agencies. If it doesn't then I don't pay much attention to them. This time is no exception.
Yesterday the one year treasury note hit a yield of 0.01%. This means that bond investors are willing to take almost no return for their investment. There is only one reason this happens. Massive FEAR. Fear of substantial loss in other investments. The last time the treasury hit yields this low was in Nov. Take a look at what equities did in November! In other words the bond boys know something that the equitiy guys don't....yet.
More interesting related news. I have read in several places backed by documentation that several large quants have blown up this week. What are quants? Maybe Jay can provise some input on this. In my research I have found that they are large investment companies that rely on various mathematical formulas to buy and sell stock. Their goal is to be equally long and short. They hope to break even on their investments and make their money on rebates from the stock exchanges. They get these rebates because they provide an extremely important job for the markets. They provide liquidity on a massive scale. This liquidity provides a floor or ceiling on share prices and prevents extreme temporary swings in share prices.
For instance if a stock suddenly feels selling pressure and the share price drops the quants' computers tell them to buy. This purchasing action prevents a crash in that equity by buying the shares that are being sold.
What has happened to several large quants this past week is that they have been forced to unload massive positions on certain equities due to their own personal loss limits. The quants purchased short positions against many low priced equities with poor fundamentals as these equities prices increased off the bottom. Many of these equities have doubled off the bottom or more and forced the quants to take massive losses. This has forced several to shut their doors and forced others yet to step aside and avoid the trainwreck.
Basically many quants did not see the bear rally coming and got caught short. The effect has been lack of liquidity and artificial demand due to short covering which has caused the rally to drag on and go higher. Coincidentally as prices rose and this dragged on more quants got pinched.
Now what does this all mean? Possibly, not probably, there will be a black swan type event.
We are overdue for a pullback. If the market does not have the proper liquidity due to the disappearing quant funds the pullback could escalate into something larger. I have noted in this blog yesterday that evidence suggests that this rally has been led by retail mostly and recently the institutions have become bearish. If prices begin to fall and fall quicker than normal, the retail investors could panic and the race will be on for the exits. I am talking a market crash.
Furthermore the market has created a pattern called a rising wedge. This pattern has a very reliable outcome of extreme and sudden reversal. Once this pattern resolves and prices begin to fall we could get our black swan type event. It would be a day that would go down in history. I am not predicting it, but I just wanted you all to know that many pieces are in place for this type of event.
Edit: I'll add to this with some information that did not have any link to an article, but was reported by several hedge funds. The strategy taken by these funds has been to short the inverse etf's and go long the small crappy stocks. This has forced the quants to cover at massive losses and resulted in huge profits for the hedgies.
The administration and Jim Cramer and all the talking heads on TV and even the United Nations has called for regulation of the hedgies because they shorted the financials into the abyss last fall. I wonder what they will say now that there may be evidence that most of this rally has been manufactured by the hedge funds. I am sure Obama will not speak up for any bears out there who have been ass pounded for the last six weeks. He still thinks there are "green shoots" of recovery visible.
Have a great weekend guys.
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On the question of Quants, maybe some of them try to be market neutral and break even on stocks to get kickbacks from the exchanges. The ones that I know of, Renaissance for example, are all mathematically focussed like Solwold says. I don't think that they try and break even for kickbacks, rather they try and be momentum players. So they have say 50 inputs into a multi-variate factor model. And when that model says buy or sell they do so and they do so with no emotion or thought as it is a computer model. The quants are the other side of the market from what I do. They are driven by formulas and could care less of what a company does or what industry it is in compared to fundamental research which is trying to find undervalued companies by looking at their business, the expectations in the market about that business and where you think it can go vs. those expectations. For example when we bought SNDA last spring we did so because it was undervalued for the franchise it has, online video games in China, for where it does business, China, and for the utility that it offers users, cheap entertainment which is resistant to economic durress. The quants would have many variables looking to see where the market was pricing Chinese equities. When those signals said buy they would have bought many Chinese equities and one of those could have been SNDA. Then you have quant momentum players that see an up and to the right chart and they will hop on as well. Take a look at that chart sometime and I know it is hard to believe but there is still value in that name. It takes a long time for a bubble or expectations to get far too high on a name because the quants and momentum players take hold, and really they have not taken as much hold as they could on that name specifically right now.
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