As money managers rushed to price in stronger economic growth, factor investors who dissect stocks by how much they’ve risen or fallen saw this strategy, known as momentum, crash on Monday like never before. Equities more sensitive to the economic cycle like value and small-cap names skyrocketed.
So while the S&P 500 is just shy of its record high, it’s been a wild week for quants even by the standards of this wild year, with many enduring violent moves rather than capitalizing on the risk-on mood.
All this recalls long-standing worries that freakish cross-asset gyrations are getting more common thanks to cheap money and investor crowding.
Quigley’s estimate for the odds of this week’s shock is in part tongue-in-cheek, based on a rule of thumb for a normal distribution of statistical data. Asset moves are not known to reliably obey this convention that says 98% of all data points occur within three standard deviations of the mean.
But even with the knowledge that market prices are more prone to outlier moves, a rotation of the magnitude seen this week was still a shock to risk models.
Quantitative strategies are designed to take advantage of relative small moves between asset classes that take place every day. They make money be sizing their positions according to the “normal” volatility in the ratios they monitor. 98% efficiency means that on any given day there is a 2% chance of a volatility event leading to unexpected losses. That’s acceptable for the vast majority of investors provided the incidence of outsized events remains low. The reason the credit crisis killed off so many fixed income macro strategies is because the dispersion in the returns broke out and stayed that way for a prolonged period.Click HERE to subscribe to Fuller Treacy Money Back to top