Tuesday, August 07, 2007
(Dis)location, (Dis)location, (Dis)Location
Attention US equity market peoples: if you haven't already noticed, you are experiencing a capital dislocation event. This (as you must already have seen) is not about the level OF the index, but the relative levels of what is INSIDE of the index. It is spelled d-i-s-p-e-r-s-i-o-n, and if you have not already been run over by it, then you are probably pursuing a dysfunction investment strategy, with an extremely low sharpe ratio, and BOTH LOW expected return, coupled enormous FUTURE tail-risk.
As described in my previous post, Q3 2007 to-date has seen the complete decimation of value and price-sensitive factors at the expense of growth, revision, surprise, and price-momentum based factors, BOTH on the tails and within the cross-section. What this means is that the better the short-term expectations AND (and this is the most important "AND") the higher the however-framed p4ice momentum, the greater the return (and vice-versa). So, things with lower quality AND low momentum (irrespective of valuation, and, in fact in spite of it) the more it seems to go down.
In my previous post I hypothesized why this might be so using a flight-to-quality and bad-beta framework implying aggregate distaste for co's whose earnings have a higher sensitivity to market-wide earnings and similar infatuation for those uncorrelated , typically aliasing high, growth, high earnings momentum, positive earnings change etc. which are hypothesized to be more sensitive to the rate of discount which, in the markets estimation, has been newly determined to be staying put, at worst, removing hypothetical uncertainty as to the present value of a dollar of optimistic future earnings.
But there is a another possibility, and I think it perhaps more likely. SOME VERY LARGE FUNDS ARE IN THE PROCESS OF DE-LEVERAGING/LIQUIDATING (EITHER FORCIBLY OR VOLUNTARILY), THE NAMES OF WHICH WILL BECOME APPARENT TO ALL SHORTLY. This means that they are having to buy-in their shorts presumably a combination of expected under-performers, most likely from the realm of the shitty, the overvalued, the large cap & cap-weighted ETFs or all the preceding, and sell/puke those generally smaller-cap alpha-generating things that are "cheaper" or exhibit characterstics of value that are likely to yield positive relative return in the future, AND THEY ARE SELLING THEM WITHOUT RESPECT TO PRICE OR VALUE BECAUSE THEY HAVE TO, either because investors have asked for their money back, or to meet margin calls elsewhere, or because their lenders have pulled their lines, and so on.
Make no mistake: This is a liquidation event, and it is of a magnitude much larger than seen in 04, 05, 06, or early 2007, and rapidly approaching that of 2002. While GS/Mark Carhart's $10 bn Alpha fund was down 8% in late July, IT IS LIKELY THAT THE LOSSES FOR HIS AND SIMILAR FUNDS IN AUG TO DATE WILL STAGGERING BY COMPARISON.
For those under-leveraged and under-exposed, this will be opportunity. For those investing in the typical beta fund with concentrated smaller-cap longs versus ETFs, with any kind of value bias, there will be no exit. The response by the end investors - particularly HNW retail who for the most part are absolutely clueless about risk, and generally feedback trading, the will be redemption PANDAEMONIUM as knaves digest the realization that oh-so-much is, in fact correlated to credit, and that their loss-tolerance is, contary to bluster and swagger, very small indeed.
Anyone care to take a guess or two as to "WHO" precisely is getting waterboarded by the market??!?