Choppiness amid Calm: Explaining an Anomaly

Chidem Kurdas
A surprising reason people give for disappointing returns in certain investment strategies in the past year or two is that markets are choppy.

How can that be when financial news is full of stories about the low volatility in stock prices? By those accounts, markets appear to be extraordinarily calm.

Part of the discrepancy is in the statistics. What’s meant by choppiness is something standard measures of volatility do not always catch—namely, a penchant for prices to reverse fast and often.

Depending on its time frame, this type of jerkiness can lie below the radar of volatility stats. Prices go up & down a lot, but the ups and downs mostly cancel out, so there is little or no change.

But the movements do mess up trades based on quantitative models that can’t keep up with the frequent jerking around and macro investment views that assume a stable trend.

As a result even a highly respected manager like Graham Capital Management has trouble making money. Founded in 1994 by Kenneth Graham Tropin as a quantitative model-based futures trading shop, Graham Capital compiled a top-notch performance record, attracted clients and diversified its strategies. Assets are at $6.8 billion.

Recent returns are less than stellar. One investment program, a global macro strategy that can trade in any market and is supposed to protect against slumps in traditional asset classes, lost about 5% year to date.

Equities are not the only place prices have been moving back & forth. The choppiness manifests in other markets such as currencies. Graham evidently played the wrong side in both stock and currency markets.

So sharp reversals make life hard for quant and macro traders. Is there a broader meaning to the phenomenon? Does choppiness say anything about the near future of the markets where it occurs? Could it have predictive power as to the economy or part thereof?

I’ve asked those questions for years & received different replies. There’s one main point that observers agree on: choppiness indicates market participants in general are more uncertain than usual. They don’t know what way to go, hence a lot of reversals.

Pessimism as to market prospects is not necessarily a source of uncertainty. Thus in 2008 a consensus emerged that markets were going down. At the time trend-following quants had a field day betting on the decline. There wasn’t much uncertainty about that.

Why the current uncertainty? It’s mainly fueled by mixed economic signals – in the U.S., strong second quarter GDP growth versus reverses in housing – and the Federal Reserve’s unprecedented money creation program known as quantitative easing, the full consequences of which are unknown.

Beyond that, anyone who says they know what’s going on is, well, subject to reversal.

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