Quant Quakes and Dull Summer Tapes
There's Something Very Familiar About All This
This past week you should have received a flurry of notes from me. A quick summary for those who may have missed one:
For this note, I apologize in advance if this comes out a bit “reaching.” I find myself thinking clearly, but struggling to put into words the juncture we find ourselves in. Whenever I struggle to articulate, I ramble into a story. So I am going to tell you a story that will hopefully help bring my thoughts into focus.
In August of 2007, I was working downtown on the equities trading floor for one of the largest banks in the world. I was a young dumb smoker back then, and because there was no smoking allowed indoors anymore, you had to be the bad boy and go outside, freezing in winter or sweating in August. Naturally if there were others like you, you gathered together, and occasionally made friends. On this beautiful, hot sunny day, I remember walking over to a few quant bros I had shared a smoke with before. They worked on the floor above me in structured credit (I had no idea what that was but it sounded super smart and profitable). I noticed their hands were shaking as they took out another cigarette and lit it end-to-end with the ones they just finished. It was a Wednesday, so I said “wow you boys really went hard on a Tuesday night eh? Who was the client?”
Mind you, they would get no bad judgment from me. For years in the 2000s I put together weekly drinks every Tuesday — every Tuesday — at a basement dive bar in the West Village known for great wings and cheap beer called Down the Hatch. It started with a few friends who were looking for a cheap night to break up the stretch between Saturday and Thursday nights, but soon traders were bringing their clients and we would pack this NYU college bar with 20-30 bros playing darts, eating wings, and downing happy hour pitchers of Rolling Rock. The bill would come in at like $60, and we would tip $200. After a while I would send a bloomberg out every Tuesday afternoon spooling up clients and traders, and the title of the bloomberg slide was “G.O.U.R.M.E.T.” which was short for “Gentlemen Of Unsavory Reputation Meeting Every Tuesday.” The assistant manager Pete attended my wedding years later… that’s how much time we spent there. As I say — no judgment about turning it on with a solid Tuesday night.
Back to August 2007.
“So who’d you take out last night?”
Quant Bro 1: “Nah we were here last night.”
Cloudbear: “What happened?”
Long pause. QB1 takes a very long drag. Now that I look closer — these bros have not slept.
QB1: “We lost a billion dollars yesterday.”
Cloudbear: “Ummm…. what?”
Ok, you’re probably thinking “a billion dollars is a few minutes of QE — hedge funds lose this all the time.” In 2007, the last time you heard “a billion dollars up in smoke,” it was when LTCM lost four yards over a few weeks back in 1998. This was… a lot. A billion. In. One. Day.
QB2: “That’s not the worst part.”
Cloudbear: “Okaaaaay… what?”
QB2: “We know we are going to lose a billion today. And we’re pretty sure we are gonna lose another billion tomorrow. There’s just no bid. The market is gone.”
Silence. These guys are doing an LTCM in under a week inside our bank, and nobody knows or cares? All I can think about is how I am stuck long a million bucks of my bank’s stock in restricted bonus comp I haven’t been able to sell yet.
Cloudbear: “You guys serious? Ok…I guess I’ll see you guys…I better get back to the floor, gotta make a few calls.”
QB1: “Hey… don’t say anything.”
I had no idea what subprime CDOs were at the time. I was a simple cash equity guy. But I spent the next few days doing a lot of learning.
As the summer grinded on, the market was recovering from a mini correction that many won’t even recall. The S&P shrugged it off and went to an all-time peak of 1576 on October 11th 2007 before commencing the slide that would see an epic 2008 kick off with Jerome Kerviel doing a Nick Leeson at SocGen, Bear Stearns going to the wall, and eventually Fannie Mae, WaMu, Lehman, AIG, Madoff…you know the saga. This July-August 2007 correction became known as the Quant Quake. After a few weeks, news broke that Goldman Sachs Global Alpha — a market neutral L/S quant fund with over $11 billion under management — had lost -8% in July and then crashed -23% in August. Global Alpha was founded in 1997 by the renowned quant Cliff Asness (who left GS in 1998 to launch AQR), and was once called “the Cadillac of hedge funds.” The explanation for the smash was that quant funds were following similar computer-driven trading strategies, and their crowded positioning ran into a giant de-grossing “stop out” at the same time. Investors found it curious, shrugged it off, and moved on.
Source: PauloMacro via Bloomberg
I find myself thinking back to those days because I am getting vibes. No, it’s not a “2008 is dead ahead” kind of vibe. It’s a just a weird feeling for now, like Biff in Back to the Future 2.
