April 2020 Issue
Welcome to a social distancing version of the Jenkins Journal. I’m safely working from home on the island of Jersey in the Channel Islands. Working from home for us at TORA is pretty straightforward as the platform has always been a cloud based system. This means that working across our 7 global offices in three continents, can largely carry on as normal. Of course normal, is a very subjective word these days and we are hopeful that the new normal reverts somewhat in the coming days and weeks. We are also cognisant that many others aren’t so lucky, and are having to make personal and professional sacrifices at this time. I wish you all well and, most importantly, stay safe.
The big story – The crisis laboratory
A crisis can be viewed as a type of petri-dish.
Inside the crucible of transforming markets, years of theories are being put to the test. Suddenly real world data is available, and ultimately recreating a new reality where previously there were only hypothetical discussions. As this market enters the second month of coronavirus domination, I have been sifting through the data collected throughout Wall Street to see what we can learn from these markets. In today’s issue I’d like to discuss two of them.
Index funds didn’t break the market
The last sustained trip for the VIX above 20 was during the so-called of “Vix-mageddon” of February 2018. The sudden end of a prolonged period of calm in the markets, the spike launched a thousand memes (“Short the VIX” was the finmeme craze of the spring) and wiped out investors sanguine about market turmoil.
It is true that a symptom of the market over the past few weeks has been decreased liquidity and higher spreads. Goldman Sachs research found the average spread in the S&P 500 moved from 4 basis points to 14 basis points by the end of the first quarter. Anecdotally we’ve routinely seen spreads consistently push 50 basis points at certain times.
Since the nature of this crisis is a macro shock, there is extremely high correlation between individual stocks, and sectors, and the overall market. This wasn’t the case in recent previous shocks. Which means index funds have not really been an issue, if anything index funds are helping liquidity in the market.
It looks like there are some emerging (or perhaps accelerating) patterns in the market that are driving liquidity spikes. Trading has increasingly crowded around market open and close. This is standard activity (whether in a crisis or not) but we are certainly seeing an increase in scale. For example, before the crisis the ‘busy’ period around the market open lasted around half an hour, however, during this period of increased volatility we are now seeing some cases running for 90 minutes.
A similar period of higher trading occurs at the end, driven primarily by index funds. Reduced top of book liquidity means that spreads can be double or more during the more stable ‘middle’ part of the day.
Quants didn’t go bust – but they also didn’t cash in
The market believes that this is a good time to be in the high frequency trading business. I’ve seen several people discuss how high frequency trading now has a chance to shake off years of being a favorite punching bag for people who believe the markets are ‘rigged.’
A decade ago Michael Lewis’ seminal book Flash Boys brought the world of high frequency trading and front running into the mainstream, at least to a portion of the mainstream keen to read novels or listen to provocative interviews on public radio.
Since the books’ publication the quest of Brad Katsuyama, an IEX founder on a seemingly Sisphyian mission to reform the markets, moved incrementally. IEX launched but as yet has only a small portion of the market. In February, the Securities and Exchange Commission banned the introduction of a four second delay on one of the CBOE market exchanges. The regulator said “CBOE hadn’t provided enough evidence to show that it would benefit the markets by curbing ultrafast trading strategies.”
These markets provide an excellent testing ground for relative worth and performance of certain high frequency strategies and advanced algorithms. With March performance figures slowly leaking into the press, we are seeing several quantitative firms with positive performance – while others take a spill.
Unusual marketplace movements are partially to blame. Some institutional funds have seen huge losses during the first part of March – a victim of stocks and bonds reversing their usual inverted correlation. Meanwhile several systematic quantitative strategies saw gains in March, as they worked through changing market and economic fundamentals.
No doubt investment teams are furiously tweaking those strategies as April continues. Portfolio managers will be looking to predict what’s ahead for the market, whether from home or from the rented out Four Seasons in Palm Springs, where Citadel CEO, decided to relocate over twenty of his top traders to work remotely from the closed hotel. Most likely trying to find the edge over his competitors.
That said, the markets seem to be slightly calmer than two weeks ago, and we are likely to see plenty of data in upcoming weeks to prove or disprove certain HF theories.
Noted and quoted
This has been an extraordinarily busy time in the media. Here are three larger trends to watch:
- A huge symbolic change in the market is that one of the most famous exchanges – the New York Stock Exchange – has had no traders on the floor for the first time in more than 200 years, and for a good reason as – many floor traders were struck down with the virus. How much of this becomes permanent remains to be seen, but a UBS executive in Business Insider predicted that “millions” could be saved by axing the few remaining physical trading locations.
- Regulators and industry bodies globally are considering and/or are issuing delays to forthcoming rule changes and new regulations. In America, the Consolidated Audit Trail (CAT) was due to roll out in April before the SEC issued a no-action letter. While not the first delay to CAT (the process is now years behind schedule) this was the closest the project has come to getting off the ground. Compliance departments should note that technically CAT is not delayed, the SEC has just given guidance that will issue no fines for people not in compliance until at least mid-May.
- It’s all hands on deck at the world’s hedge fund desks. A piece by Robin Wigglesworth in the Financial Times describes the coming weeks and months as “an opportunity — and for many managers, a last chance — to prove their worth, according to investors and industry insiders.” A former manager is quoted as saying: “The industry will not be the same after this.” Expect extra scrutiny (and more leaks) for monthly performance figures in April, May, and June as investors look to call winners and losers and redeploy capital.