September 17, 2015

QUANTS maybe a danger to the markets

Call me old-fashioned, but in Season of the Glitch, I outlined why more volatility will emerge from our broken markets and in the past I have been adamant in my view that we should KILL THE QUANTS BEFORE THEY KILL OUR MARKETS.

There have been a number of factors that have conspired over the last decade to produce the current environment, which resembles less of a stock market than a casino -- providing fertile ground for the disruptive influences of quants, risk parity and other strategies that pay little heed to balance sheets and income statements:

• Regulation: Volcker Rule, Basel III, Dodd Frank prevented dealers from providing their classical role of ensuring market liquidity and stability -- in part because of lowered allowable leverage and, in part, because of a mandated reduction in proprietary trading activities.

• The elimination of the uptick rule in 2008: This will go down as one of the dumbest regulatory moves ever.

• The proliferation and popularity of ETFs: These weapons of financial destruction (which rebalance during the day) have taken a much larger share of trading activity as retail investors have moved away from individual stock picking and toward the use of "these baskets." (As evidence, a disproportionate amount of stock trading activity occurs in the first 30 minutes and last 30 minutes of daily trading, when ETFs "rebalance.")

• The decline in retail investor involvement

• The electronization of the NYSE: This has eliminated the stabilizing impact of market makers and specialists. In the past, human beings have used common sense; today, emotionless machines rule the day and have recently proven disruptive to our market system.

• The steady drop in commission rates, which gave brokerages less incentive to take the other side of a trade.

There are some easy near-term solutions to the adverse impact of our Brave New Market -- including the adoption of a tax on financial (stock) transactions and/or the reimposition of the uptick rule.

Unfortunately, the SEC is asleep at the switch and, for now, we have to play the hand we have been dealt.

So, get used to spending more time in a trading mode and less time in an investing mode -- and given the rise in volatility, keep an eye on your portfolio's value at risk (VAR).

My cousin Sandy Koufax controlled his destiny with his golden left arm.

However, to an important degree, we -- as market participants -- have lost control of our markets and our investment destinies.

It's a sad state of affairs that is not likely to be resolved any time soon.