Notes on the Impending Market Reversal

A note released yesterday by Barclays Capital (BCS) continues the topic of quant liquidity disruptions, the upcoming major trend reversal and provides some disturbing observations.

The recent market rally that started on March 10th has been dramatic, unexpected, and actually quite painful for the vast majority of quantitative equity managers. Based on our conversations with numerous managers in recent weeks, we believe that most quantitative managers’ portfolios were not positioned in expectation of a rally. Of the nearly 80 managers we have talked to, only one manager said they were up since March 9th and the clear majority admitted to being notably down or stopped out on their positions. These managers were both long-only and long-short quant managers using market neutral and non-market neutral strategies, sector neutral and non-sector neutral strategies, longer term and intermediate term holding periods. It is fair to say that just about everyone is bewildered and trying to understand when this rally will end.

Impending Reversal?

The key question given the dramatic performance on Thursday, is do we expect an impending reversal to happen shortly? How long do we think this current trend will continue?

In our note of April 2nd 2009, we wrote that we believed the general market rally and current trend in quant factors and themes was already over done and played out. At that point, we believed it had to end. In the prior run-up from January 7th through March 9th, the Sentiment Index was up +21%. Normally, in a reversal it loses approximately 60% to 70% of the value of the run up. As of April 1st, it was down -24%. As of the market open yesterday April 13, 2009, it was down -52%, thereby reversing over 240% of its run-up.

Normally, when we call for a trend to stop, we need to see three things. First, the trend has to have been strong and dramatic. Second, the trend has to have recently increased its trajectory in a hyperbolic way, to have accelerated its performance. And third, we need to have seen the trend reverse the clear majority of the prior trend.

On all three dimensions, we believe the current market conditions are clear and unambiguous. The current trend is strong and dramatic. We have clearly seen the trend accelerate, with the performance now coming from the tails of the distribution. And, we have reversed far more than the build-up of the prior trend. Think of a rubber band. What we are trying to identify is when the rubber band has been stretched far past its normal state. We believe unambiguously that we are at that point today.

All of this was true a week-and-a-half ago so we felt comfortable then calling for an end to the underperformance in Sentiment and the outperformance in Valuation. Today, we feel even more comfortable. And while on average, it takes 10 to 15 trading days after this condition has been met for the reversal to take hold, so we still have time, we certainly haven’t been proven right yet. As a prior boss repeatedly reminded me, and I humbly note here, there is no difference, though, between being early and being wrong.

If it is any consolation to analyst Matthew Rothman, you are not alone. Saying that the market has discovered an antigravity drive would be an understatement. However the outcome, based on Zero Hedge conversations, now may very well be comparable to the parabolic days of July 2007 which were followed by implosion of several large quants, and made even the previously unshakable Goldman Alpha to have a 30% down month. It may end up being poetic justice if history rhymes yet again.

Tomorrow: I discuss the ever increasing impact of quant strategies over the past 10 years, and how it can be mapped in real time.

Comments

[User 241672:]

A fool and his money are soon parted. When Larry Kudlow screams at me to buy! buy! buy! I know we're near the top.

Everything I needed to know about Wall Street I learned from Broiler Room.

Apr 16 01:26 AM

[Steven Hansen:]

i am glad to see the big boys bewildered also at the lack of both technical and fundamental basis for the market run-up. For me the market in the short term never does what you expect. it would be fun to be a trader in this market but i am in the wrong timezone (i need my sleep).

Apr 16 01:35 AM

[Pessimistic...:]

I feel Friday will be the end of this run .As mentioned in this article the run has lasted basically much longer than expcted. Listening to the pundits that follow as a profession, when they begin in unison that this ramp up is unaccountable and an elephant walk up the indices, it is time to take notice. It has run large and in charge and is due for a pull back. GE reports Friday the markets will move on their report.. they are that big. They are the bell weather, the telltale sign of if we are slowing the contraction or if the bloodletting will continue. .. I am poised to pull the trigger now. I have also tight stopped many of my big runners for the occcasion. Bull or bear.. a run is a run is a run.. no hog here.

Apr 16 01:42 AM

[Celcius:]

You are so perma-bull. Make some stock picks publicly and lets track your success!


On Apr 16 12:49 AM Cetin Hakimoglu wrote:

> Trepidation begets a bull market and euphoria completes it.

Apr 16 01:51 AM

[Fighting Yoda:]

Breaking news from WSJ:

Mall owner General Growth Properties Inc. sought bankruptcy protection early Thursday in one of the largest real-estate failures in U.S. history, capping a precarious, months-long effort to juggle the crushing $27 billion debt load it shouldered in past acquisition sprees....

Finally it happened after much pain and delay. This might set tone for tomorrow's market

Apr 16 02:04 AM

[Jasper M:]

1) "It is fair to say that just about everyone is bewildered and trying to understand when this rally will end."
With all due respect, Tyler, Prechter called the bottom, and rally, pretty well. I know, I made $ off of it.
2) from Pessimistic Optimist - "GE reports Friday the markets will move on their report.. they are that big."
Agreed, but do you seriously imagine they are much less adept at juggling numbers than Goldman Sachs? My guess is they had a whole department dedicated to how they would use the new mark-to-fantasy accounting rules, probably well in advance of the actual change.
A pull-back at this point would certainly give the rally longer legs. But that doesn't mean it won't end up exhausting higher.

Apr 16 03:05 AM

[debtacid:]

I love those little PPT pumps up in the last hour. For grins, I picked up a few FAZ in the last minute of trading...

Apr 16 03:21 AM

[CautiousInv...:]

Hussman maintains an index constructed of economic surprises and it appears to correlate well to the overal movement in the SP500.

No matter what type of rally this is, it is exaggerated and the day the surprise arrives......the catalyst.........I think many will be surprised as to the extent and violence of pullback.

We simply have too many problems to work through and todays housing numbers, the recent uptick in foreclosures and the continuing slide in home prices only exacerbates the underlying problems that must be addressed.

Apr 16 08:47 AM

[dcb:]

this is a man who was urging buying at the top of the market on his blog, urging buying all the way down too. he has never acknowledged that we have a credit crisis at all. I can assure you if he has been following the strategy he has endorsed he has lost a fortune. He can't be trading or buying with those losses, and he believes in buy and hold and states one should never sell.

He states on his web site that he has a plan to post on blogs to bring attention to himself via posting on financial web sites. According to his site he has been banned from posting on other web sites, so I'm guessing this type of behavior is a pattern.

Lastly he presents no data in his posts to support any of his theories, and there is no rational logic to his arguments.

I honestly believe that it is just about attention seeking.


On Apr 16 01:51 AM Celcius wrote:

> You are so perma-bull. Make some stock picks publicly and lets track
> your success!

Apr 16 09:00 AM

[dcb:]

for what is is worth (and that may not be much) lets say this rally is being engineered by an investment bank who having drove many players from the market by forcing a low is now about to push the market in certain directions.

I actually think it is being pushed higher to ensure that rolled buy in buy. Almost every professional magazine and the FT has been saying this is way overstretched.

You can clearly see the effect this direction is having by yesterdays late day rally. the public has been brought in to continue the rally. As was designed.

Apr 16 09:06 AM

[Allan Frain:]

It is no longer merely that the investment banks resemble casinos. They have to significant extent turned markets into crapshoots. Fundamentals play a reduced role in market analysis and volatility reflects a new paradigm.

Apr 16 09:48 AM

[kelm:]

Time will tell of course. The fact that so any are saying we have gone too far reminds me of all those saying how oversold we were months before this rally came along. If we are in a bear market rally, which I believe, then we are in one that will end after it has pulled everyone back in and after some are starting to explain why "it is different this time and of course we have rallied 700% because of some new mystical force in the market." If the quants have largely all been caught flat footed then the market will wait till they are all positioned for the pull back and then bound higher.

This market lives to cause the most destruction to the most people.

Apr 16 10:20 AM

[reluctantQuant:]

"Ah, that so many wish to attribute to conspiracy what is best explained by incompetence..."

ANYONE who thinks that anyone (especially themselves) has any kind of a dependable road map in hand or paradigm, shall we say, for the interconnected, overlapping and counteractive forces at work in this new market regime should probably just put down that Cray machine before somebody gets their eye poked out.

"Careful, steady and disiplined" is how one trades out of a hole, and any forecast is obsolete with the next relevant tick. If any of us were that smart, we wouldn't here. We'd be reading about John Galt on the back of our boat with Andrew Lahde.

--rq

Apr 16 11:01 AM

[thotdoc:]

Just one day at a time. Take it as it comes. Go slowly. Don't be too greedy.

All the wonderful aphorisms apply.

Don't look a gift horse in the mouth? (Is that what that saying really says? Looks funny typed but I've been up since 4:30 preparing my trades.)

The up will last as long as it lasts,,then it will go down.

Oh well. Enjoy another day tomorrow. Make some money,

And think, if it does go down hard, it's just another opportunity to make more money on the way up. Then, there is the China market, and the Shanghai market, and India, and Brazil and Turkey, and, and. It's a candy store. Why complain?

G

Apr 16 08:01 PM

[Francisco M...:]

Euphoria breaks the neck of the bull and with it the bear market rally.


On Apr 16 12:49 AM Cetin Hakimoglu wrote:

> Trepidation begets a bull market and euphoria completes it.

Apr 16 11:31 PM