Quant strategy stalls amid panic buying

Here’s one more piece of evidence that something’s amiss in the US 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, for example, has one of the lowest turnover ratios in the S&P 500, according to data compiled by Bloomberg.

Ominous signal

“When you see very strong momentum combined with a sharp rise in trading volume, that can serve as a signal of overheating and speculative behaviour,” said Vitali Kalesnik, head of equity research at Research Affiliates LLC.

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 per cent in January alone. But the potential for sharp reversals was put on display on Wednesday, when semiconductor stocks in the S&P 500 slid 2.4 per cent, the most in seven weeks.

The only other instances of liquid share outperformance occurred when equities began to recover from the bear market lows in 2002 and 2009. Joseph Mezrich, head of US quantitative analysis at Nomura Instinet, says gains in the most liquid shares this time point to something else. “What you’re observing is a panicked market,” he said.