Wild Robots and Distressed Distress
Markets are whatever.
It is the last Friday in August, and I imagine a lot of traders are on vacation this week. So far it has been pretty uneventful! The S&P 500 is up about 0.85 percent since last Friday's close. Oh I mean, sure, it has swung wildly over the last four days, and, sure, last week was pretty rough, and, sure, Europe and futures are down today. But if you checked your books at last Friday's close, and checked them again this morning, you found yourself up modestly. It's if you checked them in between that you had a heart attack. There is a life lesson here.
Wild swings in equity and credit prices had little impact on European leveraged loans as market participants remained on the beach during the holiday season. This has helped the market outperform the busier and more liquid U.S. market, which fell most days this month.
That's the spirit! Remember, you can avoid many scary market swings if everyone just agrees not to trade.
But the stock market doesn't work that way so there is ... stuff. Here is Robert Shiller on "Rising Anxiety That Stocks Are Overpriced." Here is Paul Vigna on the "technical damage" of the crash. Here is Paul Murphy on Albert Edwards's 99.7 percent chance that we're in a bear market. And here is Gillian Tett on the "wild world of robot investing":
Orders are being executed at lightning speeds in huge volumes. But there is another, often overlooked implication: these machines are being programmed to link numerous market segments together into trading strategies. So when computer programs cannot buy or sell assets in one segment of the market, they will rush into another, hunting for liquidity.
Since their algorithms are often similar (or created by computer scientists with the same training) this pattern tends to create a “herding” effect. If a circuit breaks in one market segment, it can ripple across the system faster than the human mind can process. This is a world prone to computer stampedes.
There are I think two separate points intertwined there. One is that problems in one market quickly propagate to other markets as algorithmic traders seek arbitrages. That is, in some classical sense, good: If financial markets are a way to incorporate information into prices, then it is good that information from one market is quickly incorporated into prices in another. The other is that much algorithmic trading is herd-like momentum-chasing that amplifies price swings. That is, classically, bad: It means that markets don't just incorporate information, but overreact to it. (Much other algorithmic trading is market-making-driven and so dampens volatility, but from the evidence of this week you might conclude that momentum-chasing predominated.) Here is Cullen Roche on the topic ("This was not human controlled. And it was not rational."). And a JPMorgan strategist thinks that short-gamma quantitative strategies exacerbated volatility.
In other markets news, China has been selling lots of Treasuries, without upward pressure on rates, refuting the formerly popular theory "that the U.S. is at the mercy of China" because of its Treasury holdings. It is hard to short China. Gold's Chance of Acting as a Haven Is No Better Than a Coin Flip. Here's a "liquid alternative" fund that's had a rough year. ("I just need to invest better," says its manager.) And here's a pseudonymous day-trader:
CIS became a cult figure among Japan’s tight-knit community of day traders by trash talking on Internet message boards early in his career. He’s notorious for lines like “Not even Goldman Sachs can beat me in a trade.” Last year he opened a Twitter account, on which he talks about video games and, regularly, his trading.
People are worried about bond market liquidity.
This Bank of England piece on corporate bond liquidity is good! And draws clear interesting conclusions! Like:
Spreads were more volatile in the post-crisis period than in the pre-crisis period, whereas the opposite is true for dealer holdings. This is consistent with dealers’ intermediation capacity having fallen, leading to greater volatility in market prices.
Reflecting the larger increases in spreads that now follow falls in asset manager demand, we also find a greater decline in issuance resulting from these shocks.
The blessing and curse of modern markets is that they move in the direction of being more informative: If investor demand drops, prices should go down, and issuance should be harder. That's fine. The pre-crash worries about bond market liquidity were not about informative price moves, exactly, but about the risk that redemptions would lead to a death spiral as funds were unable to sell bonds. The BoE piece is evidence that volatility is up, and perhaps it is evidence that liquidity in normal times is worse, but it doesn't seem like a reason to worry about the systemic risk of illiquidity.
Elsewhere, people are worried about covenants:
Covenants, which give lenders a level of control over corporate borrowers, have steadily weakened since the financial crisis, with certain investment grade loan protections at their weakest since 2006, according to Thomson Reuters LPC, when risky lending was at its height. Restraints on high yield bonds are loosening to an extent not seen in at least four years.
I feel like this is an even more evergreen worry than liquidity.
Distressed desks are having a rough time.
The last few years have seen very few defaults by U.S. corporate borrowers, which have made them pretty boring for distressed-debt investors, though I guess those investors have kept things interesting by branching out into Argentina and Puerto Rico. But now that there is distress in corporates -- particularly in the energy sector -- things must be more fun, right?
A team of distressed-debt traders at Jefferies Group lost almost $100 million this year as the rout in oil prices battered the value of bonds and loans of energy companies, according to people with knowledge of the performance.
Distressed-debt investors, who buy beaten-down debt that firms such as mutual-fund managers want to sell, have had a tough year. Goldman Sachs Group Inc.’s distressed group lost between $50 million and $60 million in 2015, people with knowledge of that unit said Wednesday.
It's a little interesting that bond dealers lost all that money in distressed. (Yes, I know, Jefferies is not a bank, not subject to the Volcker Rule, etc., but it is still basically a dealer.) People are worried about bond market liquidity being down because dealers are afraid to take big positions, but here you have two dealers who took big positions in their distressed desks. And maybe should have been more worried.
The New York Fed is having a fun summer.
From its Liberty Street Economics blog, I get the sense that the New York Fed is taking a break from thinking about the dollar to spend its time thinking about other currencies, currencies of the past and the future and the imagination. Here is a post about bitcoin mining profits:
Our estimate of the aggregate daily profit of bitcoin miners dropped below zero for several days in mid-January 2015. The average hash rate over the two-week period following the realization of negative profit was noticeably lower than the average hash rate over the preceding two-week period. It appears that diminished profit may have prompted some miners to exit the market or to reduce their mining efforts.
I do like the idea of the Fed giving bitcoin some friendly advice about how to run its monetary system. Somewhat less practically, perhaps, the New York Fed also dabbles in the monetary policy of the Society for Creative Anachronism:
A segment of this organization focuses on medieval times, and a subgroup of it concentrates on the minting of coins as it was accomplished during this time period. A posting by His Lordship Ian Cnulle to a website for a cooperative community provides some background on the processes involved in minting during the history of the society.
Apparently "a person with no prior experience should be able to produce a reasonably authentic looking Anglo-Saxon style penny in pewter." There is no discussion of whether that is a more or less profitable endeavor than bitcoin mining.
I wrote about the Dole Food leveraged buyout, which had some conflicts.
Carl Icahn owns 8.5 percent of Freeport-McMoRan and "wants to talk to the company about its capital spending and possible cuts in production." Carlyle has had a rough time with hedge funds. Jon Hilsenrath on pressures on the Fed to raise rates. Matt Klein on QE4. Joseph Cotterill on Russia's refusal to restructure its Ukrainian bond. Greece's Varoufakis says will not take part in "sad elections." There is no correlation between TIPS breakevens and future inflation unless you control for the price of oil. The Theory and Practice of Corporate Voting at U.S. Public Companies. Tim Cook didn't violate Reg FD by e-mailing Jim Cramer (earlier). Man with lucrative government-enforced monopoly is sad to lose that monopoly. Treasury secretaries watched "Hamilton." The original Palm closed. "Cream cheese is a spread, not a sandwich filling." Awesomesauce. "Baldness that says 'I've lived, I have money, here is a bracelet.'"
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