Submitted by Alessandro Balata and Francesco Filia of Fasanara Capital
Analysis of Market Structure: Towards A Low-Diversity Trap
Ever since early-2017, our theory has been that multiple years of monumental Quantitative Easing / Negative Interest Rate monetary policies affected the behavioral patterns of investors and changed the structure itself of the market, in what accounts as self-amplifying positive feedback loops.
The positive feedback loop between fake markets and investors created system instability, and divergence from equilibrium (July 2017). That is the under-explored, unintended consequence of extreme monetary policymaking. A jammed-up, stuffed-turkey market system, where it is easy to detect heavy concentration risks, all the while as its size (i.e. valuations across both equities and bonds) got ginormous:
Concentration of size on few top players: top 8 AM shops account today for $22trn, from $8trn in 2006
Size of ‘passive’ or ‘quasi passive’: considering leverage and turnover, ca. 90% of daily flows in equity today are passive
Correlation of risks across investment strategies: ca. 90% of strategies today are either TREND-linked or VOLATILITY-linked
ANALYSIS OF THE MARKET STRUCTURE: WEAKEST LINKS
As we try to substantiate the view with hard data, we now further analyze the market structure across the two dimensions which may well represent its fault lines:
Concentration of size on few top players: we use as proxy the top 22 asset managers globally
Size of ‘passive’ or ‘quasi passive’: we use as proxy the top 2000 ETFs, as represented by their largest 350 since 2007
We focus on largest ETFs and largest Asset Managers as we believe them to be the cracks in the financial system, the fault lines that lead to market fragility, hence our focus on them as a meaningful proxy for the broader financial market.
A VISUAL HISTORY OF THE MARKET STRUCTURE IN THE LAST TEN YEARS
The analysis that follows is powered by our Fasanara Analytics team, a proud addition to the Fasanara family of late. It is not intended to be a finished product, but rather a work-in-progress, along the way of truth-seeking data mining. Any feedback/critique, please reach out, happy to collaborate and incorporate.
Our analysis framework borrows from complexity theory and network modelling, we investigate phase transition from one state of the market to another by applying ideas from earthquakes prediction, information theory and pure mathematics.
We model the market as a network of agents (the nodes of the figure below) whose strength of interaction (edges, distance) is computed using a non-linear transformation of the pairwise correlations; for details on the network construction please see Onnela et al. “Dynamics of market correlations: Taxonomy and portfolio analysis”.
We provide a visualisation of the market structure as modelled by a graph where each node represents an ETF, and the length of the edge represents the strength of interaction (inversely proportional). Please note the density/crowding of the nodes (market concentration) in September 2008, and how it looks after the pressure is released, in the healthier conditions of 2010. The stiffness of the market increases again after 2015, leading to a current situation of high density and potential danger as the market is no longer able to absorb shocks.
more of course,,,,,,,,,,,,,,,,
http://www.zerohedge.com/news/2018-07-12/towards-low-diversity-trap-visualizing-dna-market-crash?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+zerohedge%2Ffeed+%28zero+hedge+-+on+a+long+enough+timeline%2C+the+survival+rate+for+everyone+drops+to+zero%29
Realist - Everybody in America is soft, and hates conflict. The cure for this, both in politics and social life, is the same -- hardihood. Give them raw truth.
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