volatility


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Like everyone else today, I’m reading Katherine Burton’s amazing inside look at Renaissance Technologies, the greatest hedge fund in history.

Among their secrets – hiring non-finance people with science and math backgrounds, avoiding contact with Wall Street at all costs, constantly developing new edges as old ones grow stale – their ability to stick to what they know works is probably a key one. How did they learn this lesson? By “losing” a billion dollars in a few days, how else?

When rivals and former investors are asked how Renaissance can continue to make such mind-blowing returns, the response is unanimous: They run faster than anyone else. Yet all that running hasn’t always kept them on their feet when everyone else stumbled.

In August 2007, rising mortgage defaults sent several of the largest quant hedge funds, including a $30 billion giant run by Goldman Sachs, into a tailspin. Managers at these firms were forced to cut positions, worsening the carnage. Insiders say the rout cost Medallion almost $1 billion—around one-fifth of the fund—in a matter of days. Renaissance executives, wary that continued chaos would wipe out their own fund, braced to turn down their own risk dial and begin selling positions. They were on the verge of capitulating when the market rebounded; over the remainder of the year, Medallion made up the losses and more, ending 2007 with an 85.9 percent gain. The Renaissance executives had learned an important lesson: Don’t mess with the models.

Sudden, sharp drawdowns will frequently have us second-guessing our portfolios. This is only natural – in the heat of the moment, it always looks like something is wrong or that action must be taken. One of the worst things an investor (or advisor) can do is throw away the playbook in response to temporary volatility or unexpected events.

Renaissance is using leverage in their Medallion fund, so they’ve got considerations beyond performance to consider – like the survival of the company. For most investors, this is not the case, so capitulation is always a wrong move.

Don’t mess with the models.

But, although Renaissance has been around for quite some time and weathered a number of storms, you still have to remember Long Term Capital Management, who were brought down by leverage.

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Shares of Valeant Pharmaceuticals International Inc. VRX, +12.33% shot up 9.7% in active premarket trade Wednesday, after Morgan Stanley analyst David Risinger turned bullish on the drug maker, citing the belief that major risks to the company have already been priced into the stock. Risinger raised his rating to overweight, after being at in line since October 2015. He raised his stock price target to $42, which is 58% above Tuesday’s closing price of $26.60, from $27. “Risk of severe financial stress should diminish as [debt] covenants are renegotiated and [Valeant] pays down debt, and deleveraging should drive equity value accretion,” Risinger wrote in a note to clients. Regarding risks of drug pricing resets, Risinger said Valeant has already experienced step downs in net pricing and access, and he his valuation estimates already account for generic competition for the company’s most controversial drugs–Isuprel and Nitropress–over the next six to 12 months. The stock, which was on course to open at a 2 1/2-month high, had plunged 74% year to date through Tuesday, while the SPDR Health Care ETF XLV, +0.08% had tacked on 3.1% and the S&P 500 SPX, +0.03%had gained 6.6%.

The increased volatility, sharp drop, sharp rise, are generating some nice profits in this stock.

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Oil hasn’t been at the forefront of market discussion for a little while now. It may be soon. Oil is falling once again.

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With it, now, are the energy stocks who’s fortunes are tied to the oil price. Oil supply is plentiful and no-one on the producer side seems willing to cut or halt production. Therefore, you would expect further pressure on the price of oil.

Will the overall market follow oil and oil stocks lower?

Who really knows. But the overall market as measured by SPY, DIA, QQQ, hasn’t really moved anywhere in the last month or so. Earnings reports that beat, go nowhere.

Cheaper oil for me is great if it brings down petrol prices, and good for manufacturers/producers that use oil somewhere in their product.

But the overall market just doesn’t seem to like lower oil prices. If oil continues lower to retest the previous lows, the overall market may just follow again.

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U.K. property funds with about 18 billion pounds ($23.4 billion) of assets froze withdrawals as investors sought to dump real estate holdings in the aftermath of Britain’s vote to leave the European Union.

“It’s reminiscent of Bear Stearns’ subprime funds before the Lehman debacle,” Bill Gross, a fund manager at Janus Capital Group Inc., said on Bloomberg TV. “The system doesn’t allow liquidity to flow into the proper places. If these property funds are just one indication, perhaps there will be others to follow. I think it’s something to worry about.”

Henderson Global Investors, Columbia Threadneedle Investments and Canada Life suspended trading in at least 5.7 billion pounds of funds on Wednesday. Aberdeen Fund Managers Ltd. cut the value of a property fund by 17 percent and suspended redemptions so that investors who asked for their money back have time to reconsider. Legal & General Group Plc said Thursday it is adjusting the value of its 2.3 billion-pound property fund by an additional 10 percent.

Investors are pulling money from U.K. property funds as analysts warn that London office values could fall by as much as 20 percent within three years of the country leaving the EU. During the financial crisis of 2007 and 2008, real estate funds were similarly hit by redemptions and forced to halt withdrawals, contributing to a slump in property prices of more than 40 percent from their peak in Britain.

Wednesday’s moves brings the number of U.K. firms curbing redemptions to seven since the June 23 vote. Henderson said Wednesday it had temporarily halted its 3.9 billion-pound U.K. Property PAIF fund along with feeder funds due to “exceptional liquidity pressures” and the recent suspension of other funds. Columbia Threadneedle halted its 1.39 billion-pound PAIF and feeder funds and Canada Life froze four funds totaling 450 million pounds.

“The problem with open-ended funds is you do start to have panic selling, so you really have no choice but to suspend the fund,” said Jason Hollands, managing director at investment firm Tilney Bestinvest. “There’s an inevitability to this now.”

‘Penal Consequences’

Aberdeen, which marked down the value of its 3.2 billion-pound U.K. property fund, said it was halting withdrawals for 24 hours as of noon Wednesday so clients who asked for their money back have time to reconsider their orders.

“Shareholders wishing to redeem will do so at a price which is subject to the above dilution adjustment in order to reflect the current market environment and the fact that short-term trading in the property market has relatively penal consequences,” the firm said.

With the real estate tremors echoing the last financial crisis, the growing fear is that failure to control aftershocks from the Brexit vote will propel the economy into recession. The pound sank to a fresh 31-year low as the fallout continued to reverberate through financial markets.

“We can’t ignore what’s happening from a redemption request perspective or the closing perspective,” Wayne Bowers, chief executive officer of the international asset management arm of Northern Trust Corp., which manages about $900 billion of assets, said in an interview in Sydney. “You can’t brush that under the carpet. Then you’re looking at other assets that are under, or are potentially under, similar pressure.”

Cash Levels

Investors pulled money from real estate funds in the lead up to the vote, depleting cash levels. Standard Life Investments was the first money manager to halt withdrawals on Monday, followed by Aviva Investors and M&G Investments. About 24.5 billion pounds is allocated to U.K. real estate funds, according to the Investment Association.

There’s “a loss of confidence in the valuations being used” by fund managers, said John Forbes, an independent real estate consultant and former tax partner at PricewaterhouseCoopers LLP who specializes in property funds. “The retail funds had cash and balances in liquid shares” to manage normal levels of outflows, he said.

Aberdeen said its funds had invested in 79 U.K. properties across sectors including retail and industrial.

“The portfolio was positioned defensively prior to the referendum with one of the highest levels of liquidity of all similar funds and having sold all its quoted property companies investments in the week prior to the referendum and holding this as cash,” the firm said.

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US stocks are more or less, back to their starting point prior to Brexit.

Clearly, no-one actually has any idea what will happen and what effect that will eventually have. So stocks are probably going to fluctuate in a sideways range until some form of consensus is formed.

This, if correct, opens up a number of trading strategies that are effective in sideways markets. The increased volatility, if it remains, is obviously going to be an issue, but is potentially manageable.

Obviously in this market, one needs to remain extremely flexible, as positions are likely to be very vulnerable to news flow over the next few days certainly and likely couple of weeks.

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There has been and still is the idea that ‘diversification’ is a risk management tool, and to a certain extent, it is. However, diversification linked to leverage, changes that assumption into something very different.

Diversification, of uncorrelated markets, or securities, say Nike common stock and London mortgage securities, would seem prima facie, unrelated or uncorrelated. However a trader who holds these same securities as another trader, now correlates those securities as any trader who holds them becomes linked to every other trader who holds those securities.

When leverage forces you to sell, you sell what you can, not what you should.

Now when selling what you can, that may very well be Nike, and now you have a rush for the exits in Nike, of every trader on margin, who holds London mortgages [or whatever]. In times of stress, all markets and securities are correlated by the traders who hold them. Diversification is a chimera.

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Well I didn’t think it would actually happen, but the UK did actually vote to leave. Of course this is what should have been allowed to happen when the Confederacy wanted to leave the Union.

A referendum is not legally binding, but it would be political suicide not to secede now that it has been put to the vote.

Markets are in turmoil, but, they will settle. There is a buying opportunity here. Maybe not today, but somewhere in the next few days/weeks.

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