Anthony Malakian: Rise of the Machines

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Anthony Malakian, Buy-Side Technology

We really aren’t that far from machines taking over the world. Believe me, my friends, Skynet, the diabolical self-aware network from The Terminator, is not far from becoming reality.

The lack of a Y2K catastrophe must have lulled us into a false sense of security. How else can you explain viewers tuning in to Jeopardy to root for “Watson,” IBM’s super-computer, to beat its two human counterparts? And Watson didn’t just triumph over Jeopardy grand-champions Ken Jennings and Brad Rutter; it absolutely bludgeoned them without mercy or emotion.

I didn’t get much sleep those February nights. Then I read more chilling stories about how technology is changing our world—seemingly for the best, but that’s only to keep us humans from panicking. The first item that grabbed my eye was about Derwent Capital, a UK hedge fund set to open its doors this month. According to CNBC.com, Derwent will use posts from micro-blogging site Twitter to predict market movements, and then trade off that human sentiment.

Derwent poached Indiana University professor Johan Bollen, who famously found that Twitter could predict with 87.6 percent accuracy “the daily up and down changes in the closing values of the Dow Jones Industrial Average, and a reduction of the Mean Average Percentage Error by more than 6 percent,” according to an article published by Bollen and two of his colleagues in the Journal of Computational Science. The CNBC article quotes Derwent founder Paul Hawtin, who says the fund will be able to deliver 15 to 20 percent returns.

I say: Twitter? Really? The site on which Charlie Sheen spouts on about “\#tigerblood” and “\#winning” can somehow be leveraged to deliver huge returns for investors? This must be some kind of joke.

Elementary, My Dear Human
Yes, trading firms have been trying to find ways to unlock the power of social networking. The fact that a hedge fund was created to address the issue is unique, but hardly scary. And then I noticed a Wall Street Journal headline: “Wall Street Bets on Debt That Doesn’t Exist.” What? Apparently, banks and hedge funds are creating credit-default swaps (CDSs) tied to General Motors Co. debt that the car manufacturer doesn’t have. Bond holders of this semi-fictitious product will get paid out should GM default. Yet, as the Journal reports, “GM canceled $40 billion of debt in bankruptcy and has pledged to cut its remaining $4.6 billion bank loan [in full] this year.”

The industry claims this helps when speculating on the company’s creditworthiness—that it’s a form of hedging. In that same article, Tabb Group’s Kevin McPartland, a man I trust, said, “CDS prices are the de facto benchmark used to measure the state of the credit market.” He doesn’t seem too concerned, so why should I be?

But to me these are signs that the smartest kids in the room are once again at play now that some calm has returned to the marketplace. According to a recent report from hedge fund data provider Eurekahedge, North American hedge funds have experienced net-positive asset flows for 13 consecutive months, the longest continuous stretch since 2004. Globally, assets under management in hedge funds have surpassed $1.7 trillion, the first time that’s happened since September 2008. And the Dow remains high despite turmoil in North Africa and Japan.

That’s good—I want hedge funds and banks to be successful because at their best it’s good for the economy and investors. But at their worst, such firms can bring the global economy to its knees. It makes me question how much the non-technologists at these firms understand about the algorithms they employ, and the extent to which trading heads grasp the upside—and, more importantly, the downside—of the products they create.

I read an article from Data Center Knowledge the other day that quoted a prediction that by 2020 we would have 35 zettabytes of data storage available globally, or roughly 35 billion terabytes. Watson—the machine that will one day rule us all—was able to trounce humans with less than 1 terabyte of stored data, and is learning to understand human idioms everyday. Sleep well.

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