The Character of the Market Is Changing

Not too many people remember the second week of August 2007, but for others, that week will be forever etched in their minds. And in many ways, it should be etched in yours as well.
During that infamous week, we witnessed an event that would later come to be known as the 2007 Quant Meltdown. While the events that unfolded took place in a relatively small pocket of the financial market, their effects would have consequences for all investors.
Algorithmic or quantitative investing has been on the rise for many years. One of the most prominent (and horrific) examples was Long-Term Capital Management – which, by the way, is one of the most ironic names possible, considering the fund engaged in high-risk, leveraged arbitrage trading strategies.
LTCM used a quantitative strategy to take advantage of arbitrage opportunities in fixed income markets. In 1998, when a financial crisis in Russia triggered a flight to safety, the firm sustained massive losses and was in danger of defaulting on its debts.
The amount of leverage LTCM used magnified its problems. Using $100 of borrowed money for every dollar of its own, LTCM held massive positions representing roughly 5% of the entire global fixed-income market. When a ‘once-in-a-lifetime’ event occurred that was not factored into their computer models, it brought the financial world to its knees.

This post was published at FinancialSense on 05/23/2017.