Don’t blame the quants for market turbulence

Are the robots to blame for the current market turbulence?

A lot of commentators, including US treasury secretary Steve Mnuchin, seem to think so, much to the disgruntlement of pugnacious hedge fund manager and quant Cliff Asness.

“Here’s an idea,” tweeted Asness. “Stop saying silly accusatorial things about what you don’t understand, to defend your boss’s prior comments on the market rising being all him.”

Algorithmic trading dominates today’s markets and has undoubtedly influenced recent trading conditions, but blaming the robots misses the point. Firstly, market selloffs have always been rapid, panicky affairs, even when humans were doing the trading. Secondly, while trend-following algos may briefly accelerate market downturns, other algos act as shock absorbers, buying when prices hit technically overbought extremes.

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Thirdly – and most importantly – the sell-off was merited. Valuations were out of whack after a huge run-up and the spike in bond yields necessitated corrective action. Sentiment was at bullish extremes and positioning was wildly lopsided. It was all too easy, with risk-adjusted returns hitting record levels last year as stocks kept going higher without enduring any kind of pullback.

Finally, markets recalibrated. Don’t blame the quants for what is ultimately a healthy market correction.

Bear market remains unlikely

Stocks may suffer further near-term falls but a bear market remains unlikely.

This looks like a classic correction in a bull market, an unwinding of "very overbought conditions", to quote Merrill Lynch, which advises investors to buy on weakness due to "still supportive" fundamentals. US earnings continue to look stellar.

New Federal Reserve chief Jerome Powell is untested but is likely to follow Janet Yellen's dovish script. Recession – the usual bear market catalyst – remains a distant prospect. In Japan, an index representing economic conditions has hit new highs, while German economic data has been similarly impressive.

Crowded trades – in this case, bets against volatility and a reckless assumption the only way for stocks was up – “can be a lot more unstable than most investors expect”, Allianz’s Mohamad El-Erian noted last week, with the excessively long period of market calm creating “the technical conditions for violent air pockets”.

Stocktake warned a fortnight ago a sudden increase in volatility could trigger a violent unwinding, but concluded any sell-off was unlikely to be decisive. That remains true today.

Volatility likely to persist

Talk of a bear market looks overstated, but things may stay shaky for some time yet.

The bottom-fishers came out en masse last Tuesday – the S&P 500 rallied 4 per cent from its intra-day low, the biggest intra-day gain since October 2011’s major market bottom – sparking hopes the previous day’s carnage may have been climactic. The selling soon resumed, however. Thursday’s one-way traffic saw stocks suffer their first double-digit correction in two years.

Traders should not have been surprised; markets typically retest significant lows. Fat Pitch blogger Urban Carmel notes that since 1980, roughly 85 per cent of market corrections have “had some sort of low retest”. PastStat blogger and quant trader Kora Reddy unearthed similar data, examining what happens after indices hit a 20-day low the day after being at a 20-day high. About 80 per cent of the time, markets hit further lows.

It’s all Obama’s fault

“Big mistake.”

Donald Trump's declaration that stock markets erred by falling when there is "so much good (great) news about the economy!" was typically Trumpian. When it comes to partisan market coverage, however, Trump was outdone by Fox News host Sean Hannity.

Barack Obama was to blame for the falls, said Hannity. Obama’s economy was “so weak”, so “we had just artificially cheap money”, but the “era of cheap money” is now ending.

That would be fine, only Hannity was singing a different tune three weeks ago. “GREAT AGAIN,” his website headlined. “Dow SOARS 31% Under TRUMP, Best Year Since GREAT DEPRESSION.” The article quoted a strategist, saying: “This is all about policy. You’ve got lower taxes, less regulation and confidence in the economy is high.”

So if stocks rise, it’s all due to The Donald. And if they fall, that’s Obama’s fault.

Trump: two wrongs don’t make a right

Political partisanship is not confined to Trump supporters, as Harvard economist and former treasury secretary Larry Summers proved last week.

Trump “took credit for the stock market rally”, said Summers. “Therefore, it’s fair when people assign him responsibility for the decline.” Trump, by irresponsibly calling his political opponents treasonous, “has to raise unease in markets”.

Summers, a smart academic, ought to know better. Firstly, markets have long learned to ignore Trump’s cheap political barbs. Secondly, Trump’s market boasting was irritating but blaming him for declines, whilst understandable, isn’t “fair” – two wrongs don’t make a right. “If I take credit for sunshine, should I be held responsible for a rainy day?” to borrow from one Twitter respondent. “No. My claim should be evaluated, not blindly indulged.”