The perils of complacency. . . .
. . . in the age of quants and the madness of machines
“In recent decades, mainstream economists insisted that markets are highly efficient, and do a near perfect job of digesting available information and correctly pricing assets today to take account of future events based on that information. In fact, nothing could be further from the truth. Markets do offer valuable information to analysts, but they are far from efficient. Markets can be rational or irrational. Markets can be volatile, irrationally exuberant, or in a complete state of panic depending upon the emotions of investors, herd behavior, and the specific array of preferences when a new shock emerges.”
MK note: I might add that the volatility, irrationality, potential panic and the rest when applied to the markets extends beyond humanity itself to machine-driven algos as well – hence the madness of machines, as I have called it past writings. We should keep in mind that computer driven trading models mimic human behavior by design. As a result, the bad behviour necessarily comes with the good. Computer driven trading is an extension of human psychology, not set aside from it. After all, the goal in the end is get ahead of the competition, a decidedly human endeavor.
This morning’s Wall Street Journal features an article on algo/quant trading platforms. In it, the authors bemoan the lockstep trading of the various quant funds and their potential to exacerbate a trend. The lemmings in short can take the market higher; they can also take it over a cliff.
Quants today comprise 29% of stock market trading volume – a percentage large enough to dictate momentum in either direction depending upon if they are buying or selling. I agree with James Rickards. There is a peril in being complacent and thinking that all of this will end well, or that because the trading is dominated by algos and quant platforms that somehow the markets have suddenly become immune to the history of panics, mania, crashes and collapses that frequent economic history. That quant is every bit as human in the way it acts and reacts as the programmers that gave it cyber-life.
The best way to guard against the power of quants moving against you and your portfolio is to own gold and silver. The lemming with the parachute owns precious metals.