Former fund manager here.<p>Yes, there is herdlike behaviour. But why?<p>Here's a little story about my investment career.<p>I once hired a guy for a fund I was partner in. He was a proper old school equity investor. He'd fly around the world to different countries and visit businesses. He'd think about each country's prospects, each industry, and each company. He'd meet withe the CEOs and look them in the eye, and ask them whether his company was gonna make money. I shit you not. He's come back to the office and share his thoughts on why one country was good, why this industry, why this business. It was a different story each time.<p>Another guy I worked more closely with on a fixed income desk. We'd think about different countries, their bonds, their IR rates, swaptions, etc. There's be some global stories inevitably, but a lot of local ones too and we'd chat about what to do in our trading book.<p>Then there was quantitative FX trading, another one of my projects. We'd look at things that affect currencies, patterns in the prices, anything you might imagine arrives as a live feed. And we built the infrastructure to trade the regularities that we found. Quite a lot of research and execution infrastructure. But at the end of the day, the computers are doing what? Looking at a variety of information and judging what will happen. Just like my two colleagues.<p>Fast forward to the last few years. Pretty much every conversation I have with anyone in the investment business talks about one thing: QE and zero rates. There's only one thing that matters for everything now. When interest rates are really low, what happens? Everything is worth buying. Buy houses, buy stocks. Buy them in the developed countries, buy them in EM. Sell options.<p>What used to be a conversation containing rates as an ingredient has become a conversation only containing rates.<p>People, and computers which learn what worked for people in the recent past, have gone from a rich market conversation about many things to one about just QE.<p>It will be interesting to see what happens in the near future. I can't think of a lot of bubbles that were deflated in a controlled manner. And I also expect more differentiation in equity debates. Company does this, industry does that.
As the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion.<p>When passive funds <i>as a group</i> have net outflows, all their holdings must be reduced in roughly the same proportion. But passive funds <i>as a group</i> cannot reduce their holdings by selling stocks to each other! It's impossible to take water out of a boat by scooping water from one spot and pouring it back into the same boat in some other spot!<p>Therefore, to reduce holdings, passive funds (or their broker-dealers) necessarily must find <i>other</i> -- i.e., <i>non-passive</i> -- buyers willing to take those stocks at some market-clearing price. Alas, everyone else, in the aggregate, also owns the same stocks in the same proportion.<p>Potentially, this can produce temporary imbalances between <i>passive</i> net sellers and <i>non-passive</i> net buyers that get corrected via declines in price. Passive net sellers, being price agnostic, do not care; they're on automatic.
Clifford Asness sums up my feelings about this article pretty well: <a href="https://twitter.com/cliffordasness/status/1077757633472299008?s=21" rel="nofollow">https://twitter.com/cliffordasness/status/107775763347229900...</a>
Many (if not most) quantitative hedge funds are dollar neutral, which means they have one dollar short for every dollar long. There are typically additional constraints about having equal long/short exposure on each industry and investing style (momentum, value, etc).<p>So contrary to the article, most of these funds don’t take broad bets for or against the market. What they are really doing is correcting the relative valuations of each individual company by shifting bits of capital away from overpriced companies and towards underpriced ones. That doesn’t have the effect of raising or lowering broad market indices.<p>Now there are of course other investors who take broad directional bets on the market but those are probably more likely to be discretionary bets rather than systematic.
Markets are moving much faster but we’re still using the same scale on the x axis (time). We’ve seen a 4,000 point drop so far but if that occurred over a one year period we would have called it a recession. However if the market recovers in the next few months we’ll interpret this as the continuation if a 10-year bull market.