Quant Vs Discretionary

I thought I prefer discretionary approach in managing investments.

There are, however, two different opinions in my mailbox this morning, and I am leaning towards the one of quants. Interesting?

Let's start with the opinion of Jan Bylov, the chief analyst at Nordea Markets, that I have been regarding discretionary in judgement so far. He writes today:

All kinds of wild opinions, forecasts and reasoning are circulating making it hard to stay convinced of anything beyond the next up or down tick. This week, however, an interesting quote surfaced from fund manager Ed Yardeni: "I am running into more equity portfolio managers who are fully invested bears." (9 November 2009)!

Now, aside from the paradox of being bearish and fully invested his observation may hold a very revealing truth: a lot of investors remain very skeptical about the "validity" of the post March 2009 asset gains!

Of course, bears and bulls both have powerful arguments behind their opinions, but whatever argument it should never blind us to the fact that we just don't know how the future will unfold. So why are so many still bearish of the future… in spite of huge asset gains everywhere?

Well, according to behavioural studies investors (and other human beings) always oscillate between a mental state of euphoria and despair and while this probably makes life more exciting it certainly doesn’t make it easier to invest ones money.

Fortunately, as our mental state constantly oscillates between euphoria and despair we can actually use Ed Yardeni's observation of the"…fully invested bears" to claim that such underlying "skepticism" strongly suggest that the overall post March 2009 global recovery hasn't run its course as "skepticism" is distant from the mental state of "euphoria".

Further, should bears be fully invested it also suggests that this group of market operators are very sensitive to short-term price swings; even a brief setback may cause them to exit as they clearly remain unconvinced about the prudence of being invested in all the cyclical markets like stocks, credits, commodities, emerging markets and the cyclical sensitive currencies.

Being Friday 13th some investors may even be more sensitive than at other times and below you will find some charts revealing price levels where "fully invested bears" may place classic exit orders, and as you will observe the levels centre on setbacks from early October and early November.

Finally, be aware that convinced bulls typically take advantage of the same levels as the unconvinced investors… to load up!

This in itself sounds pretty bullish, and is a manifest of simple trend following. Should be fair enough till it works. Note, he is quoting Ed Yardeni ...

However, the quants at Societe Generale have a message today, that may be a mirror of my concerns expressed yesterday, or a confirmation of my expectations (they should be rather expiring now?) for euphoric adoration:

Our equity surprise index highlights movements which are specific to one market and cannot be related to more global movements. Over the past week, the equity surprise index has risen sharply after the stock market’s performance.

The last time equity surprise rose this way was in March 2009, when stocks had led global markets early into the rally. This could therefore be another early sign of an acceleration of the rally, or an overshooting by equities

Note, that the surprise index for equities was also so high at the January 2009 highs in the equity markets. Click on chart to enlarge, courtesy of Societe Generale.



In order to spice up the confusion, let's look at the message by Tim Bond, the head of asset allocation at Barclays Capital, as he wrote on Tuesday! One of my friends described it being "seductive rhetoric", but Tim starts with winning the attention of the cautious reader on around page 3:

In digression, we doubt that the business sector will continue to exhibit a pronounced tendency to increase leverage during economic expansions on the same scale that was seen in the 1980s, 1990s and earlier in the current decade. Business cycles are likely to display overtly Hobbesian characteristics (nasty, brutish and short) over the next few years. Under such circumstances, wise CEOs will avoid high leverage.

However, as any banker these days, when assertion of banker's supremacy is needed, concludes at around page 7:

Pragmatically, we should expect that the prevailing phase of very low real interest rates will produce a boom in asset markets that is followed – or even accompanied – by a similar boom in economic activity and unexpectedly fast GDP growth. We highlight that both trends are mutually reinforcing.

So, guys, unintended (?), but "seductive rhetoric" invites you to join the reflation trend, that unfortunately is "likely to display overtly Hobbesian characteristics (nasty, brutish and short) over the next few years".

As the strategists at JPMorgan put it in style of "mechanical monetarism" last week (my emphasis added):

Equities and credit have recovered much faster than the economy, and though hard to prove, they have run way ahead of so-called fundamentals. Even if this is the case, we would argue that this is not a negative, but exactly the purpose of monetary easing. Economists call it the monetary transmission mechanism, because it is through lower funding coats and improved asset prices that monetary policy will affect the economy. Given the greater importance of asset prices in the modern economy, we increasingly find that asset price movements create their own fundamentals, rather than the other way around.

Well, if the reflationists are right, why central banks are not targeting asset prices and "their own fundamentals" as they happen to get excessive and destructive like Internet bubble, housing bubble ...? This also implies that central banks are always successful on the upside, but systematically fail on the downside? You know whom you trust?

Coming back to practical stuff on earth, Christopher Wood, the strategist at CLSA Asia-Pacific Markets, wrote yesterday:

...oil is for now a proxy for risk.

But get it adjusted for USD debasement blurb and keep in mind that George Soros wrote:

... positive feedback process is self-reinforcing. It cannot go on forever because eventually the participants’ views would become so far removed from objective reality that the participants would have to recognize them as unrealistic. Nor can the iterative process occur without any change in the actual state of affairs, because it is in the nature of positive feedback that it reinforces whatever tendency prevails in the real world. Instead of equilibrium, we are faced with a dynamic disequilibrium or what may be described as far-from-equilibrium conditions. Usually in far-from-equilibrium situations the divergence between perceptions and reality leads to a climax which sets in motion a positive feedback process in the opposite direction. Such initially self-reinforcing but eventually self-defeating boom-bust processes or bubbles are characteristic of financial markets, but they can also be found in other spheres. There, I call them fertile fallacies—interpretations of reality that are distorted, yet produce results which reinforce the distortion.

Be careful! Missed the difference between current quant and discretionary? Respect the trend, but be ready for both directions ...