Asset Allocation

There have been four events in the past few weeks that are cause for concern:

  1. Quant Quake 2.0: Over the first ten days of September, Momentum stocks traded down around 10% while Value stocks traded up about 6% – a massive intraday change on a single day delivering most of the change. Meanwhile, the market itself barely moved.
  2. Repo Interest Rate Spike: A week after Quant Quake 2.0, overnight repo rates spiked to 10%, defying the US Federal Reserve which spent days pumping additional liquidity to bring rates back in line.
  3. General stock market volatility in August saw eleven days where markets moved more than 1%.
  4. Drone/Cruise missile strike: A missile strike on critical oil infrastructure in Saudi Arabia knocked out a considerable amount of oil production.

The common theme of the ructions is uncertainty.

The Quant Quake 2.0 is reminiscent of Quant problems in 2008 just before a significant market downturn:

This may be a re-run. Post the 2008 Quant Quake 1.0, quantitative strategies became far less popular. Quantitative approaches had a renaissance over the past five years – the ructions may be a sign the momentum trade has again become “too crowded”.

The lack of an explanation is as concerning as it was in 2008. There are plenty of competing theories as to the cause. Momentum is not a strategy Nucleus follows, as our investors and superannuants are longer-term investors whereas momentum is a high turnover strategy for traders, prone to sudden reversals as we saw earlier this month.

The Repo market had a similar dislocation:

I won’t go into the details as they are quite technical, the overarching narrative is some critical parts of the “plumbing” of financial markets are blocked up and defying the US Federal Reserve’s attempts to unblock them. And while the repo market issues were sudden, problems in other parts of the plumbing (e.g. interest rate on excess reserves) have been seeing issues for a year or so now.

Once again there are a number of competing theories as to the reason – none of which are broadly accepted as the reason. Uncertainty is high.

Next, we saw considerable volatility in stock markets:

Some of this “choppy” trading has affected the momentum issues above. Sudden movements in opposite directions often cause that strategy to lose money.

The larger issue is that volatility often indicates uncertainty and before significant downward changes in stock prices, we often see an increase in volatility like this.

Finally, we saw drone/missile strikes on Saudi Arabia take out significant oil infrastructure:

There is uncertainty over how direct Iran’s involvement was and whether it will spark war in the Middle East. Higher oil prices will also act as a drag on the economy. As the higher oil prices are likely temporary, they are less likely to spark additional capital expenditure.

On their own, none of the four factors represents an imminent threat to investor portfolios. But, together, they are an indication there are issues with the global economy and financial system. Given:

  1. There are very high levels of corporate debt
  2. Banks (particularly in Europe) are not very profitable and still over geared
  3. Consumer spending is weak globally
  4. Monetary policy is in uncharted territory in many countries

the margin for error has shrunk – a dislocation in one area could see contagious effects in other markets.

For example, If we see ructions causing a large company or bank to fail, then corporate bond yields would likely spike higher. Central banks have spent ten years trying to get interest rates lower (to spark corporate investment), and a spike in yields would undo most of this. Then there would be flow-on effects with other corporates dealing with higher interest rates and more defaults.

I’m not saying this is imminent, just that the market is vulnerable. There aren’t signs of fire yet, but there is enough smoke to be wary.


Great work again Damien - well articulated!


The current situation bears all the hallmarks of the GFC . Hence l believe the next crash will be a real doozy . Holding my powder very dry . Cheers , Ramon .