The highly emotive market response to the Covid19 crisis may have overrun fundamentals for the time being, but Kathryn Kaminski, chief research strategist at AlphaSimplex, an affiliated investment manager of Natixis, said ‘crisis alpha’ can still be found within emotional responses.
“What’s great for us systemic investors is we don’t have to make gut decisions,” said Kaminski in an interview with Investment Magazine’s Market Narratives.
“Emotions have to dominate for us to see some of the trends that defy efficient market type theories, and we’re seeing that, but we have built intuition into our portfolios which react to the world as it changes.”
Negative rates and negative oil prices are just some of the dislocations investors have faced as the pandemic spread sends shockwaves through economies, but Kaminski, who has taught financial theory at times throughout her career, said it helps to unpack the emotive response itself.
Kaminski will be speaking at Investment Magazine’s upcoming Absolute Returns Conference on a session entitled ‘Systemic investing in a dislocated market’. You can secure your digital pass for the event to be held on September 23-24 here.
“I’m a fan of the adaptive markets hypothesis and thinking about markets as an ecology or an organism that is changing over time,” she said.
“The current market ecology includes people who move faster today than they did ten years ago, and that’s why Covid19 was surprising to me, we saw the sheer drop versus the depth versus the width of the crisis, which showed the velocity at which things move.”
Kaminski said it’s important to look at the participants within markets to understand how their emotions will drive movements, particularly given people behave differently as individuals as opposed to groups.
“A lot of people are driven by the winds of hope rather than the threat and fear associated with the potential risk of this particular crisis,” Kaminski said.
“And since the market is a best estimate of what the real price is, given none of us know how this was going to play out or what it means, the amount that emotions are driving the market seems logical.”
With technology and information empowering investors, both at home and within institutions, Kaminski agreed the current participants are made up of retail investors, those with Robinhood trading accounts speculating on market gyrations, as well as institutional investors seeking to make sense of new societal dynamics.
And while market sell offs don’t signal ‘instability’ within markets, Kaminski said a classic equilibrium perspective has been undermined this year as investors suddenly, and repeatedly, change their minds about the mood and outlook.
“What’s concerning is how bimodal the market has become, with bouts of smooth sailing then suddenly everyone awakens and decides that everything is terrible in two days,” she said.
“These moments of calm and then moments of crash are challenging for investors as it shows the market is that fragile, and we never know how acceleratory an event might be.”
The sharp selloff in March certainly spooked investors who were shocked to see such drastic value destruction in a short space of time, but Kaminski said there was a responsive recalibration of institutions who ‘bought the dip’, arguing their long-term fundamental outlooks were still valid.
“We then saw this fantastic momentum trade in April, and another big resurgence in August,” Kaminski said.
“That seems to be the current dynamic, flipping between peaceful, happy, everything is fine and then suddenly everything is falling apart.”
From a financial theory perspective, this is consistent with the narrative of trying to deal with a crisis, where markets often have sustained periods where they are run by expectations and emotion, rather than market efficiency.
“Sometimes the market is very efficient through periods, and sometimes it’s run by emotions, so we need to be adaptable,” Kaminski said.
“Systemic models are supposed to change as the fundamentals change, and since it’s so hard to know when that’s going to happen, we want to be as malleable as possible to detect changes in our positions.”
While many have argued central bank stimulus has destroyed trends and manipulated markets, Kaminski pointed out that new trends emerge, even if they are not as predictable as that which stimulus is attempting to combat.
Whether it’s the 2019 drop in US bond yields, massive movements in commodities, interesting US dollar trends and signs of an inflation theme emerging across futures markets, Kaminski said systemic investors take advantage of these by measuring and adapting to the changes.
“Stimulus and other interventions won’t create the trend it was trying to avoid, but it creates new trends,” she said.
“So what we’re doing is measuring across asset classes, across different speeds using different methodologies, and trying to put risk where risk is best served.”
One such trend is to take a short position in the face of long term stimulus, which Kaminski admitted can often fail to extend.
“We saw short signals, but we have to see consistent negative momentum in asset classes to be confirmed to go short,” she said, pointing to large short positions in oil that worked well, and some in equities, though the V-shape recovery made executing that trade difficult.
Another market signal Kaminski has observed is the large position tech has in indices.
“I expect we’ll start to see it shake out in the markets as people start to question whether they are actually diversified,” she said.