Friday, 20 July 2018

What's 25 years among friends?

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SwissInvest strategist Anthony Peters recalls the fear and fun of Black Monday – and has another bash at the quants

Anthony Peters, SwissInvest Strategist

THE ORIGINAL JOKE was the one about the two economists who meet on the street. The first asks the second, “How are you?”, to which he receives the reply, “Compared with what?” In last week’s column, I took something of a swipe at quants and their obsession with benchmarking everything, so I suspect that if the conversation had been between two quants, the reply would have been, “Don’t ask me, I’m benchmark neutral”.

I was surprised by the number of people who responded to what I wrote last week on indexing and in the course of the week I have had enough conversations on the subject to – I hope – justify a follow-up.

One of the sharpest points came from a pension fund trustee, who referred to benchmarking as a WMD and one that he would love to be able to avoid.

I referred briefly in my piece to the rather strange situation where the application of indices, bespoke or other, can barely be of constructive assistance in asset-liability management. I’m not quite sure how pension funds measure their liabilities – the dark art of the actuary is closed to me – but I can’t see that benchmarking assets to some market model is of much use.

In reality, indexing assets does nothing for the investor, almost everything for the asset manager and absolutely everything for the consultant actuary.

In terms of being able to hide when markets fall, indexing is of immeasurable value. This is particularly relevant as we reflect on Black Monday – October 19 1987. The volatility in markets overall during the past five years has of course been on a completely different scale to the Crash of ’87, but in terms of single-day impact, I can think of nothing comparable.

I LIVED THROUGH that crash and to anyone who was there – and is still here – it remains an abiding memory. The fall of the house of Lehman came close, but was in many ways less traumatic.

In 1987, there was no hiding behind being “index neutral”. It went down, you knocked it out. But the most significant factor in 1987 was how private clients (or their account managers) shipped it out. They got topped and tailed and the story was of one very senior executive at a Swiss bank – who shall be nameless – who walked onto the trading floor and instructed his traders to buy anything and everything the clients were selling. The firm, quite obviously, made a killing.

In October 1987, petty retail took a major spanking. That never happened again and henceforth retail bought every bear panic until the dotcom crash of 2001 showed that not all sell-offs are buying opportunities.

There was laughter on the floor – and cigarettes and alcohol – and, as shell-shocked as we all were, we got on with it

A reminder: the Dow peaked in intraday trading on August 26 at 2,736.60. On October 14, it closed at 2,412.70. Then the fun began. Friday October 16 saw it open at 2,363.90, trade up to 2,396.21 but then drop into the close to finish at 2,246.74. On Black Monday, it opened at 2,046.67, traded in a range from 2,164.16 down to 1,677.65 – that’s 22.5% high to low – and closed at 1,738.74.

On Tuesday, it made a new low at 1,616.21 but by Wednesday it had closed at 2,027.85. Between August 26 and October 21, the market did a high to low of 41%, and yet it closed the year higher than it had started it – if only by 56 points.

And you know what? There was none of the “We’re not axed to bid” nonsense. Market-makers were called market-makers because they made markets and in an age when earning US$25,000 in a day’s trading was really good, I saw my US Treasury trader in London down US$1.5m at lunchtime on the 19th but go home up over US$2m at the close – and all from client-facing business. That’s what “risk on” really meant.

MORE TO THE point, there was laughter on the floor – and cigarettes and alcohol – and, as shell-shocked as we all were, we got on with it.

Hedging was out because the market was moving too fast and swapping duration-weighted hedges hadn’t been properly developed yet. I recall first hearing a trader make a two-way market on a spread rather than a price basis and thinking he must be on drugs. Sorry Lol, all is forgiven.

Risk is like energy – it can be converted but it cannot be destroyed. If clever risk management was half as clever as it purports to be, then we’d all be holding retirement-fund-sized positions in the stock of the banks we worked for and Lehman would still be fighting with Bear Stearns over business.

Indexing and all the quant models don’t stop markets from going up and down – the end-clients are still as exposed as they ever were. It’s the fund management companies that aren’t. That, in my view at least, is wrong. I could go on. Instead, I will go out on the 19th, drink a quarter of what I drank on the same day 25 years ago and still have twice the hangover. Time takes its toll on the body more than it does on the memory.

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