Wednesday, January 23, 2008

Fire In The Theatre (of Crowded Trades)

Such a funny old day in the USA. It would seem its the day that, if you find yourself in the crowded traded, you are kicking yourself for NOT taking some of the chips off of the table. Homebuilders are UP. REITs are UP! Banks, IBs, Regionals, all are UP! Highly Leveraged Mortgage REITs are UP. If I asked YOU any day EXCEPT today, you'd (or the Average Hedge Fund Manager) would have called these things detritus, or worse. Short Interest reflects this widely held (perhaps too widely-held view.

At the same time, the average Hedge Fund Manager's favorite (and perhaps too-favorite) trades are, to put it mildly, suffering from the effects of an episode of "GET ME OTTA HERE, NOW!". This is true of Oil, Oil services, especially true of Mining (RIO, CLF, FCX) buggeringly the case for speculative glamourous thematically popular high momentum growth stocks (AAPL, FSLR, DECK, GOOG) catastrophically true of agricultural-related things like Fertilizer or ag supply-related stuff (POT, AGU, LNN), all which have been the most loved (and humped) amongst the best and the brightest managers in 2007, and which accounted for most of the alpha (and performance fees which they will get to keep) earned in respect of 2007.

Something has triggered the reaction - be it a forced liqudiation, an intentional unwinding, a near-instantaneous mass-change of opinion amongst the best and broghtest of the long versus short equity community, but whatever it is, it appears quasi-systematic in nature, and as suggested in Japan a few days ago, is focused upon position reversal, evidenced by the tell-tales of the volume pick-ups and relative price-action on the presumed short-side of the Street's trades. Put this together with the reversal in the leveraged speculations in other assets - oil, both precious & base metals, and the ag complex, and one might surmise that it is the forces of de-leveraging in action, be they forced or voluntary, opportunistic, or self-preservationary (a new term I've just coined).

After the tech bubble, London Business School research attempted to dissect large HF contributions to the tail end of the bubble, and their subsequent positioning. They found that they continued to increase exposures (presumably contributing to bubble itself) right to the end, yet adeptly managed to liquidate (and reverse) speculative hi-momo tech positions so as not to get hurt, and then profit from the subsequent implosion. Since then, I would argue, that the same-position or crowded-trade risk has intensified, at the same time as the natural counter-trend liquidity providing mechanisms of the market (specialists, block-traders, market-makers) has subsided. This itself has reinforced the returns to say trend-following and other divergent strategies, and so increased the need for participants "to play" either to pursue profit or as a purely Darwinian survival method caused by the feedback loop, of which Jeremy Grantham's GMO is one such reluctant apologist. But one must wonder whether these combined changes won't ultimately prevent The Best and The Brightest from exiting, causing a more spectacular blow-up of "smart and clever" but all-too-common positions, and in the process exposes an excess of hubris and incinerates many overly confident young buccaneers.


Anonymous said...

W/out a doubt some of that is taking place,C. But one has to believe that Senator Dodd voicing the inevitable is playing it's part as well.
That and the fact that it's already become almost conventional that the monolines are going to get the govie lifline as well.

Anonymous said...

We are all counterparties now.

spagetti said...

there is no doubt a lot of cross-sector unwinds, of which i might not know enough

my feeling the last 48 hours, was that 'shorting' has become the new momentum trade. and now its blowing up in their face..

Anonymous said...

Yowzah, that was one heck of a Short Squeeze yesterday. 600 points up in 15 minutes. Cool beans for the author of that one, at least till I get my hands on him!