The Elephants Are Fighting: Quantitative Hedge Funds VS Traditional Hedge Funds
When elephants fight, it's the grass that suffers. This is an African proverb, meaning that the weak get hurt in conflicts between the powerful. And in our case, the quant hedge funds grow, the traditional hedge funds close and the retail investors suffer.
According to CNBC, the stock market is on pace for its worst December since 1931, when stocks were battered during the Great Depression. And the quant hedge funds have played a key role in this. But don't let this event cloud your judgement, because we have the tools that can help you build a well-diversified portfolio that can outperform in 2019.
Quant Hedge Funds, Algorithms And Peter Lynch
The market isn't a perfect pricing mechanism. Market inefficiency is a sure thing, which often helps us make easy money.
For instance, WTI's move from $76 in early October down to $43 in late December was beyond any rational approach. What drove oil prices down this much this fast? This kind of short term volatility has nothing to do with anything rational. Supply and demand fundamentals don't change this fast. In other words, the oil crash isn't fundamentally driven but it's more a function of the overall market meltdown, fear, panic, tax loss selling and seasonal refinery maintenance. These factors have oil basically out of touch with any real market supply and demand fundamentals and instead oil seems to swing by the headline of the moment or whether stocks are going to skyrocket or plunge on any given moment.
Furthermore, the algorithmic trading strategies (ATS) have weighed on the recent oil crash. A lot have to do with non-physical trading in oil futures and traditional participants have been largely replaced by computerized models.
On that front, some recall that in May 2010, approximately $1 trillion in market value vanished from the U.S. stock market. In a joint investigation performed by both the SEC and Commodity Futures Trading Commission, it was determined that the Flash Crash was initiated by Waddell & Reed, a mutual fund company located in Kansas. On May 6, 2010, the Kansas firm’s ATS created an order to sell $4.1 billion of E-Mini S&P futures contracts, and domestic equities. This particular high-frequency ATS was programmed to feed orders into the June 2010 E-Mini market to target an execution rate of 9% of the trading volume calculated over the previous minute, but without regard to price or time. A year prior, it took the same firm over five hours to complete a trade of this size. But on May 6, it took the ATS only twenty minutes and drove the price of the E-Mini down approximately 3% in just four minutes.
Actually, the amount of trading being done by machines with no human oversight has grown to staggering levels. According to this article from Financial Times:
The quantitative hedge fund industry is on the brink of surpassing $1 trillion of assets under management in 2018. The amount of money managed by quant hedge funds tracked by HFR, a data provider, rose to more than $940 billion by the end of October 2017, nearly double the level of 2010, and flows have continued to be strong, according to hedge fund executives.
The growth of Two Sigma, one of the leaders of the quant hedge fund industry, is emblematic of the shift away from traditional hedge fund strategies. The New York-based firm’s assets have swelled from about $6 billion in 2011 to more than $50 billion in 2017, putting it roughly on par with the best-established quant powerhouses such as Renaissance Technologies and DE Shaw."
When it comes to the U.S., out of nearly 20,000 trading firms trading in the U.S. equity markets, a few hundred of them engage in ATS.
What we all need to understand is that in the short term fundamentals mean less than ever before, so investors have to keep their stomach in check through the increased levels of volatility. But stock prices and fundamentals will converge sooner or later. This is why investors have to grab the opportunity and pick companies with healthy balance sheets, low key metrics, proven management teams that are also takeover targets. Because eventually the fundamentals do matter. And Peter Lynch has said:
People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game."
Tilson, Cordier And The 174 Hedge Funds That Closed In Q3 2018
Meanwhile, it has been a very difficult year for the traditional hedge fund managers despite the fact that the S&P 500 (SPY) hit record highs in August 2018.
According to Bloomberg, an estimated 174 hedge funds were liquidated only in the third quarter of 2018 globally.
On that front, we encourage you to listen to this interview here with Whitney Tilson, one of the most popular hedge fund managers whose career has gone south over the last years. Whitney Tilson talks about value investing, portfolio management, short selling etc. Whitney Tilson closed his hedge fund Kase Capital last year.
Also, James Cordier is one of those energy-focused fund managers who lost all of his clients' money, in the neighborhood of $150 million, according to this article and YouTube video here.
Our recent OPCO, WLB, GST, GEN, QHC, CSU and MIK Calls
While new quant hedge funds open and many traditional hedge funds close, we recently recommended our subscribers buy OurPet's Company (OPCO) at about $0.70 per share.
Among other catalysts, we noted that OPCO was a takeover target.
And OPCO was acquired at $1 per share a few days ago.
As a result, our subscribers made significant profits just a few weeks after our recommendation.
On top of this, we have 100% success with our bearish calls from 2012 until today. No, this is not a typo. Our latest successful bearish calls for our subscribers are:
1) Westmoreland Coal (WLB) at $11 per share and Gastar Exploration (GST) at $1.10 per share. Both companies filed for bankruptcy, as forecast in our articles.
2) Quorum Health (QHC), Capital Senior Living (CSU), Genesis Healthcare (GEN) and Michaels Companies (MIK) returned from 40% to 135% in just one month.
Market Outlook 2019
We don't see a major economy entering recession next year. However, we expect the global economy to slow over the next several quarters and 2019 to be a year of high volatility. This is when investors do need thematic investing.
Thematic investing will prevail in 2019 with me and my team of high-caliber analysts being ready to help you build a well-diversified portfolio from 5 sectors (mining, energy, healthcare, industrial, consumer goods).
Specifically, we have a bunch of bearish ideas about highly leveraged companies and bullish ideas about financially healthy companies with STRONG catalysts that can deliver significant returns even if the markets remain bumpy.
Our High Conviction List For 2019
Our high conviction list for 2019 includes a bunch of excellent bullish ideas similar to OPCO.
Our high conviction list for 2019 also includes a bunch of excellent bearish ideas similar to CSU, GEN, QHC, MIK, WLB and GST.
Since January 2016, we have locked in profits from more than 45 short and long ideas for our subscribers generating 40% per pick (average) while holding the stocks less than one year. As a result, we have received 5-star rating and outstanding reviews.
Happy holidays and wishing you a healthy and successful 2019!