Market hackers running out of ammo

From hedge fund manager Bill Fleckenstein

My friend believes we’re getting closer and closer to a moment when quants [computer-driven trading not based on fundamentals] no longer rule daily trading, as their universe is losing participants that underperform. The ones that remain are desperate, trying feverishly to chase what’s working. He contends that the higher the market goes and the faster it rallies, the more certain and ugly the collapse will be.

He went so far as to suggest that when this unwinds, some big Wall Street firm will essentially go out of business and that the building it occupies will be, in his choice word, depopulated. When I responded by saying, wow, you’re more bearish than I am, he replied: No, it’s not about being bearish. It’s just a fact.

This collapse, when it comes, will have impact far beyond the rarefied world of Wall Street finance. Companies will go out of business or cut back severely. Workers will lose their jobs, maybe their homes too. We may be about to see a real life crisis of capitalism unfold before us. And the wreckage will be severe.

I’ve been trading stocks and options considerably lately, and thus am following the market closely. It’s just not been real rational of late. XYZ announces a gigantic loss and huge writeoffs for the quarter – and the stock goes up. This is what Fleckenstein is talking about. The buying of XYZ isn’t being driven by the fundamentals of the stock, but instead because some quant trading program decided XYZ was undervalued compared to the spread of Japanese corporate bonds against Euro junk bonds, so it shorted orange juice futures and bought XYZ as a hedge (while simultaneously doing 100 other trades.) It’s just outta control. Fleckenstein suggests the day of reckoning is nearing.


  1. While I agree that some market moves are illogical, I don’t see how this translates into a seriously detrimental effect on companies outside the trading world.

    For example, if XYZ announces a gigantic loss, whether or not anyone buys its stock is largely irrelevant to its internal operations. It either gets on the stick and does a turnaround, or it fails. That’s not market driven. Only if XYZ needs to raise money by selling stock does the market come into play.

    Likewise if the opposite happens (PQR has great fundamentals but the market sells), if anything this is actually a plus, since PQR can repurchase its own stock at undervalued prices, reduce dividend overall payments, and be even more competitive than before.

    As I see it, a collapse in the market is more likely to have an effect on pension plans and disposable consumer income. This WILL affect companies and their bottom line, but through indirect economic effects and not through the market itself.

  2. As I see it, the underlying problem in the market is the credit crisis which was triggered by the subprime debacle.

    Credit is increasingly difficult to get, and that raises business costs. Also, major portions of the credit market have just locked up. Such crazed trading is a result of this, the cheap credit party is over, and quants increasingly desperate to make profits.

  3. For businesses relying on credit, this is doubtless an issue– while businesses lending money will prosper. Obviously there are more of the former, else the problem would not exist.

    Ultimately, though, the drying up of cheap credit is the predictable outcome of the credit binge of the Bush administration. Like other scarce resources, credit has a limited supply and cost reflects demand. Just as the price of brass and copper has risen because of the billions of rounds of ammo going to Iraq, government’s ravenous consumption of credit can’t help but affect the market.

  4. Also, if major Wall Street brokerages and investment houses went belly-up, all the businesses that supply them and the stores nearby would take a major hit too – something that just happened in Orange County when several mortgage companies went bankrupt.

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