Introducing Dalpha
Dalpha stands for dead alpha. This is the alpha that shows up in some longer-term performance records of some funds or backtests of momentum strategies with data from time periods when there were no computers, telephones, even cars and electricity.
More importantly, dalpha is the hypothetical (backtested) alpha from time periods when strategies based on mathematical models were not even used. No one can know the actual performance of those strategies in the distant past had they actually been used to invest real money.
In recent years there has been a significant change in market dynamics. After 2008. and especially after 2013, central banks play a dominant role in equity markets with the goal of sustainable uptrends.
The two bear markets shown in the above chart after the peak of the dot com bubble in 2000 with losses in excess of 50% in S&P 500 offered the excuse for central bank control. QE3 was implemented after two large corrections in 2011 and 2012 that increased risks of another bear market. QE3 continues in one form or another with the objective of maintaining the equity market uptrend. The S&P 500 index has risen about 120% since January 2013 not counting dividends.
The stocks of Microsoft and Amazon have gained about 300% and 600%, respectively, with tech stocks being the main beneficiaries of the money printing that accelerated in 2013 (although some insist it is not money printing.)
After 2013, it was clear that central banks were in control and prices went parabolic, as seen in the above chart.
Despite the stock market rise, current 5-year return (60 months) has stayed near the average at about 50% after reaching a maximum of about 220% in 1999. The 5-year return rose to about 200% before the 1987 crash and recently in 2014 it was about 150%.
Despite equity market pumping with QE and other means, returns have stayed below their average before the dot com crash. The annualized return of Dow Jones Industrial average since January 2000 is about 4.3% before dividends while from 1914 to end of 1999 it was more than 6%. See this article for more details.
The alpha realized in the past by some relatively simple trading and investment methods, for example momentum and trend-following, is not coming back. The deteriorating performance of CTAs in the last 10 years is a strong indication of this. See this article for data and details. Some of the reasons for the alpha deterioration mentioned in that article are:
- Limited flow of dumb money
- No barrier to entry and crowded space
- Algo trading domination
Therefore, Dalpha can be used to qualify any alpha claims because of past records or backtests, as follows:
“This is not alpha, it is dalpha”
meaning that the alpha in past performance and data is now dead.
About the author: Michael Harris is a trader and best selling author. He is also the developer of the first commercial software for identifying parameter-less patterns in price action 17 years ago. In the last seven years he has worked on the development of DLPAL, a software program that can be used to identify short-term anomalies in market data for use with fixed and machine learning models. Click here for more.
