A few weeks ago, I wrote an article for GuruFocus about Jim Simons (Trades, Portfolio), the man considered to be the "father of quantitative trading."
Value investor Howard Marks (Trades, Portfolio) recently discussed the topic of whether he things the traditional market cycle will be wiped out by computers. Here’s what he had to say.
Emotion still trumps reason
Right up until the recent crash, the stock market had been on an unconstrained bull run for the last eleven years. This presented a little bit of a problem for Marks and his Oaktree Capital, which specialises in taking advantage of the negative part of the economic cycle. The idea that computers might banish cycles is certainly a pertinent one to his business.
“I think that the cycle comes from the involvement of people, who are still involved [in the market]. If you think I’m wrong, tell me why the market was able to switch from optimistic on October 3rd to suicidal on October 25th [the market had made a significant low that week]? In real life, things tend to fluctuate between ‘pretty good’ and ‘not so hot.’
But in the investment world, we go from ‘flawless’ to ‘hopeless,’ and clearly over the last 23 days most investors went from flawless to hopeless. At first they saw a perfect environment for growth in which nothing could interfere with the continuation of the bull market, and then three weeks later they saw a market where there was no good and everything was hopeless.”
In other words, Marks believes that the fluctuations of emotion and psychology will continue to drive market cycles, and that he doesn’t think that algorithmic trading has caused artificially high capital flows to the stock market. I agree with this assessment. Any time there is a strong move to the upside in the market, bears will grumble about ‘the algos’ juicing the market. Similarly, on big down days, bulls will complain about the same thing - just ask billionaire Leon Cooperman (Trades, Portfolio), who wants the Securities and Exchanges Commission to investigate algorithmic traders because of this.
I believe that rather than causing a bias in the market either way, computerised trading exacerbates the movements initiated by human psychology. Much of algorithmic trading is trend following, meaning that it hops on the back of whatever is happening on that particular day. Thus, if anything, computerised trading will lead to deeper cycles, rather than wiping them out.
This is good news for value investors who want to live by Warren Buffett (Trades, Portfolio)’s mantra of “be greedy when others are fearful,” or the even more evocative Baron Rothschild quote “buy when there is blood in the street." If a market panic can be made more extreme by the activities of algorithmic investors and traders, then all the better for those of strong discipline.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Seth Klarman: Value Investors Should Work from the Bottom Up
- Howard Marks: Why Investors and Dentists Are Different
- Morgan Stanley Is Betting on a Swift Recovery
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