A sea of pain

This Economist Magazine article confirms my personal experience that value investing is in a sea of pain at the moment. The reasons are quite different from the last time (during the dotcom era) when value investing was in the doldrums. This time around, people are not full of euphoria about the prospects of growth stocks -- they are just getting increasingly gloomy of value stocks which seem to be getting cheaper by the minute.

Seasonal trades in stocks

Readers of this blog have seen my discussions of various seasonal trades in commodities futures (e.g. see this article). Recently, Mark Hulbert of the NYTimes drew our attention to a seasonal trade in stocks. The strategy is very simple: each month, buy a number of stocks that performed the best in the same month a year earlier, and short the same number of stocks that performed poorest in that month a year earlier. The average annual return is more than 13% before transaction costs, and since it is market neutral, this already considerable return can be leveraged to 2 or 3 times higher. Also, since it turns over the stocks only once a month, transaction costs should not be a major problem. The strategy was developed by Profs. Steven Heston and Ronnie Sadka, and details can be found online here. Besides its simplicity, the strategy is not as affected by survivorship bias in the data set as a mean-reverting strategy, since survivorship bias would tend to lower its backtest performance by excluding very poorly performing stocks that we would short. All in all, it seems to be a market neutral strategy made for retail trading!

Economist article on quant funds

The media seems to have an endless fascination with quant funds. Here is the latest article from the Economist magazine, summarizing the postmortem published by several researchers. (Hat tip, once again, to reader Mr. J. Rigg.)

The key points are as follows:

1) Quant funds are now becoming the primary market makers in many securities, which normally would provide liquidity and decrease volatility.

2) Unlike ordinary market makers, however, quant funds are highly leveraged.

3) Because of the high leverage, in the face of large losses these market-making quant funds are forced to liquidate their assets instead of buying them, thus behaving in a way opposite to ordinary market makers just when the need for liquidity is direst.

4) Thus quant funds are actually contributing to instability of the market despite their apparent market-making function.

Fortunately, when all else has gone wrong, there is alway Mr. Bernanke to count on ...