Here’s one more piece of evidence that something’s amiss in the U.S. stock market: A usually reliable strategy used by quants is suddenly on the fritz.
Quantitative investors have long used liquidity signals to strengthen their automated models. Simply put, bets on the least traded stocks should, in theory, outperform the market because there’s a reward for taking on the extra liquidity risk.
But since December the opposite has been occurring, with the most liquid stocks rewarding investors to the greatest degree in nine years.
In normal times, heavily traded shares don’t overlap much with momentum stocks. Reliable companies carry the market higher without any frenzied buying or selling. Amazon.com Inc., for example, has one of the lowest turnover ratios in the S&P 500 Index, according to data compiled by Bloomberg.
Yet in a long-short Bloomberg index that bets on the most actively traded stocks, a hefty chipmaker presence has the gauge headed toward its best month since 2009. That semiconductor shares are rising so quickly despite a high turnover is an ominous signal, indicating that trigger-happy, short-term investors are wading into momentum, according to Vitali Kalesnik, head of equity research at Research Affiliates LLC.
Pure Panic
“When you see very strong momentum combined with a sharp rise in trading volume, that can serve as a signal of overheating and speculative behavior,” Kalesnik said by phone.“The issue with speculator money is they can come in and drive prices up and once they see signs of something happening, they quickly leave and drag prices down.”
Nvidia Corp., VMware Inc. and Micron Technology Inc. hold the biggest positions in the Bloomberg trade activity portfolio, and have gained as much as 22 percent in January alone. But the potential for sharp reversals was put on display Wednesday, when semiconductor stocks in the S&P 500 tumbled 2.4 percent, the most in seven weeks, on the heels of a disappointing earnings report from Texas Instruments Inc.
The only other instances of liquid share outperformance occurred when equities began to recover from the bear market lows in 2002 and 2009. But the difference is that in those periods this was a healthy sign because the most beaten up shares had been oversold during the downturn, enabling them to outperform off those lows when the market rebounded, according to Joseph Mezrich, head of U.S. quantitative analysis at Nomura Instinet LLC.
This time, gains in the most liquid shares are pointing to pure panic, he said.