Today Should Not Be A Surprise In The Least

Dow -2%
Nasdaq -2.9%
Russell 2000 -2.3%
AGG (Bond) – 0.4%

I Have Been Pointing Out, Since Gamestop First Appeared (video at the bottom, from August 24, referring to videos in January, February, and March)

This COMBINATION of line items should not exist. When in “risk off” mode, investors “should” sell stocks, and BUY something else, and that is bonds. They have not done so this year for a long list of reasons.

This has changed the grid from the long video (1 hour) which explained how hedge funds, and huge balanced/targeted funds have returned less than 50% of the S&P. This should NOT BE A SURPRISE. Just because YOU are looking at it that way (as fed by CNBC and your broker), that doesn’t mean that the largest most sophisticated investors look at it that way.

There is NO CHANCE they are looking at it in any other way than using the linear algebra construct that I attempted to explain in the long video. NO WAY, every person with a semi-quantitative background knows that this method is used in every optimization exercise.

You can see how unsavory my existence is (take pity on me, it’s a pity party).

  • Many have no idea this exists, and admit it (they are safe).

  • Then… there are those that have this background, and discard it for an inexplicable reason (when it is the dominant, unassailable approach, and they know it, they are better educated than I on this specific exercise, I have no doubt). Ugh.

  • Don’t worry, I published a book to try to get 65MM people from discarding their common sense when selecting a Medicare strategy, with very mixed results.

Anyways, the construct, and the fact that the correlation grid looks weird this year, since Gamestop, add Crypto on top, etc, fully explains how hedge funds, targeted retirement funds, global equity funds, etc are all lagging the S&P/Nasdaq. There are MANY OTHER areas called “stocks.” Europe (S&P less 5%), Asia (worse than that), China (BABA is LOWER than at any point since 12/2018, so WAY worse, dragging EM equity). In the US, the Russell 2000 is FLAT for more than 6 months.

In ancient times (January 2021), the NASDAQ, the undisputed leader for the past two decades, was down by well over 5% compared to the Russell 2000 through Q1. Something was clearly different, something that the other videos on the closed channel highlighted, as it occurred (I have timestamps).

Bonds have added fuel to the confusion. Bonds are now down 3% for the year. It also explains the next dynamic: fear of missing out. For example, big Fund 1 is watching big Fund 2, needs to win. Big Fund 1 sells bonds, buys S&P, making the price look higher (even almost all of the performance come from 5 stocks in the S&P). That doesn’t mean that Fund 1 and Fund 2 are unaware of the past paragraphs: definitely not, they are using the same lens that I am discussing here. There is only one optimization lens. The way they differ? Their assumptions of The Glue, the correlation grid, which an assumed grid, from which the weighting of the different asset classes (US stocks, NASDAQ, Russell, EM stocks, EM bonds, US bonds, European bonds) gets determined. People believe that they allocate the weightings, and observe the correlations. BACKWARDS. What people don’t see is that the actual weighting is then tilted HIGHER in equity, how is a targeted fund of 2035 at 80+% stocks? That is what is happening, so that the optics of the return, when the grid is docile, looks attractive. Central banks have been the backstop to create a docile correlation grid. Period.

Get The Glue Wrong, You Are Dead

The problem isn’t that the COMBINATION at the beginning gets out of whack. The problem is that gets way out of whack, and it stays there for a period. Then those that are hurt, have to sell, which leads to a cascading effect, forcing them to sell EVERYTHING, and now that grid becomes totally dysfunctional. Calamity.

If you think I am inventing this tale, that the Correlation Grid dysfunction means problems, look at these examples, I had a front-row seat, myself.

  • Long-Term Capital Management, the smartest finance people in the world, bar none, created a hedge fund, which failed, because they refused to believe the relationships among certain assets was staying dysfunctional for that long, when Russia intentionally defaulted on its debts owed to foreigners. They ran out of time, had to sell, and the vultures arrived, read it in When Genius Failed (disclosure: I knew many from that firm, many. I sat in the same department prior to LTCM’s origin). The prior video had a tale at about the 49 minute mark. They were literally the best in the world, I will never encounter any group anything close to it. Still failed.

  • Great Financial Crisis. The housing crisis had a primary root: Wall Street took advantage of the fact that the rating agencies had the correlation grid, which presumed that real estate in location A was unaffected by real estate in location B, wrong. They had the correlation too low, when it was actually higher. That resulted in tranches of asset-backed securities (ABS) were rated too high, and large investors used that ratings as a basis for buying. Sorry, it wasn’t because a stripper had 5 mortgages, as Michael Lewis implied. The same thing for AIG. Hilariously (well, maybe not hilarious) Wall Street CEOs and traders (I knew them) were hauled in front of Congress, and while the traders told the truth as coached by attorneys, the CEOs did not, when they said they were “hedged.” Nah, if Merrill Lynch was allowed to fail, it could not pay Goldman Sachs, and the dominos would fall immediately, so for any one of the Wall Street CEOs to state otherwise as an intentional untruth, but those questioning the CEOs were not equipped to ask the right question. So they got a pass. And yes, I am certain they knew it, they didn’t get to that spot without knowing it.