New Millennium, New Market

The turn of the millennium was one of the craziest times in the history of stock markets. Of course, everyone knows about the "dot-com" companies with P/E ratios in the stratosphere. Fewer people understand how the "Y2K bug" forced so much spending on tech that it drove up valuations towards the end of the 90s (and the Fed helped by pumping money). But almost nobody talks about how the market changed. The best example of that change is this chart showing the 1-day autocorrelation of the S&P 500:

It's pretty easy to see the regime change there. After a half-century of positive autocorrelation, the market flipped to negative autocorrelation. Why did this change happen? Nobody knows, but it probably wasn't just one thing. I think it probably had something to do with shrinking trading costs, faster transmission of ideas, and increased reliance on automated trading systems. Regardless of why this change happened, I just want know how it affects trading strategies.

The "Buy the Rip" Era (1950 - 2000)

In this era of positive autocorrelation, the following trading algorithm would have made a killing.

If SPX was up yesterday, hold SPX today
Else, hold cash

The backtest results are impressive. This simulation doesn't take into account taxes and fees though. I don't think this type of strategy would have been feasible to execute back then due to high fees. Again, that's probably a big part of the market change.

The "Buy the Dip" Era (2000 - Present)

In the modern era of negative autocorrelation, the opposite strategy is preferable:

If SPX was down yesterday, hold SPX today
Else, hold cash

Again, this simulation doesn't take into account taxes and fees, but the outperformance is pretty significant. It's pretty neat to see how this change in the market flipped everything.

What this Means for Backtesting

This change poignantly demonstrates the biggest risk in backtesting strategies. The data can show an extremely strong pattern for decades, and then the pattern can flip on a dime. Of course, the digitization of markets around the turn of the millennium was possibly a once-in-a-lifetime change.

I generally disregard market data from before the 2000s. I don't really care how a strategy would have performed in the days where you'd learn everything from the morning newspaper, call your broker on a landline, and make an expensive transaction to purchase paper stock certificates. The market has changed. We live in a world of instantaneous news where transactions are cheap and robots do most of the trading. Buffett and Munger are buying tech stocks. Long live the new regime!

I've Gone Mad (and Created a Trading Algorithm)

It was around 2 in the morning, and I hadn't slept in days. I was feeding a baby a bottle with one hand while holding my phone in the other. My wife had just given birth to twins a few days earlier. I was looking at the state of my investments. The chart on my screen looked like this: When the startup I worked for was acquired in 2014 I had received a $200k windfall. Being clueless about investing, I spent an hour investigating options and then chose to put it all into a robo-advisor. Over the next few years I kept adding money as the shares from the acquisition vested. The results weren't bad : 10.6% annual returns . But I had underperformed the market and that didn't sit well with me. I want to get to the next rung on the wealth ladder . The lifestyle I desire requires wealth of around $10M net worth. I want a house on the water in Florida and a boat. Now don't get it twisted: this isn't something I need . It's certainly not going to make me happy . I know...

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