Market hackers running out of ammo

By Bill Fleckenstein

I'd like to pick up where I left off in last week's column and spend a little more time talking about quantitative trading.

At a recent New York conference, investor Jim Chanos noted a couple of anomalies that, in all likelihood, are a direct function of quant trading. They highlight a disconnect between stocks and their underlying fundamentals that only a computer could love.

It turns out there are two -- and for all I know, more -- closed-end mutual funds that own mundane large-cap S&P-oriented stocks: the Cornerstone Total Return Fund (CRF) and the Cornerstone Strategic Value Fund (CLM). Inexplicably, these funds trade at premiums of better than 50% to net asset value. At one point this year, they traded at premiums far higher.

A Renaissance in overvaluation

The connection to the quant universe is that Renaissance Technologies, among the biggest quant hedge funds and certainly a very successful one, is the fourth-largest shareholder in both Cornerstone funds.

You have to scratch your head and ask: What is a quant fund doing paying a huge premium for an easily replicated portfolio?

The only logical answer would be that the stock-price characteristics have behaved in a way that makes Renaissance's computer -- which was obviously programmed by someone -- think these funds are a good thing to buy, regardless of the fact that their valuation is beyond absurd. (As an aside, I'm amazed the proprietors of this fund have not sold some shares at that huge premium for the benefit of their shareholders. But that's another topic.)

Meanwhile, a well-placed friend in the quant world pointed out that on any given day, 50% to 70% of stock trading is probably done using a quant strategy of some form. He suggested that folks should think about stocks as financial instruments, looking at volatility, correlation to other stocks, membership in an index and other such characteristics that pertain only to price action.

That's what the computer-driven models at quantitative funds do, setting aside the fundamental questions of what a company actually makes or does and what that business is really worth.

If all that is the case, it explains why, at the margin, the market seems to have become more of a commodity than it has been in the past.

Obviously, no group of operators can change the market's ultimate direction. But they certainly can distort it for a time.

The model of a modern debacle

My friend believes we're getting closer and closer to a moment when quants 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.

• Video: Quantitative funds take hit from market volatility

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.

Aboard the clinical-trial train

Now for a shift to the biotech industry, which, unlike others, should show immunity to the economic slowdown that I foresee. Just as I was getting involved with Nastech Pharmaceutical (NSTK, news, msgs) -- which I introduced to the Contrarian in June 2006 -- it hit some speed bumps.

Continued: A chance to deliver

 1 | 2 | next >