Some may not like the note this morning. In my 36 years, I have learned many things...I still do each and every day. I have learned egos are a killer in the industry. I have learned the market is mirror - you see what you want - and very often, get just that. If you feel it is rigged, you will likely see those types of results. If you feel you cannot win, that too will likely be the outcome. If you feel that defeatist, victim process of the proverbial "what goes up must come down...", well, then that does not explain why we are at 24,000 - and not 0.
Months and Months
For well over the last two years, for several times a week, I had copied a line into the morning note. "Pray for a correction." Each time, I stated that it would drive a huge new bearish viewpoint, scare the masses away again, create significant values, drive everyone to doubt their convictions, cause thousands of advisors to be certain the end is near again - and then....the surge in fear would end. The stage would be set for a brand new leg in the powerful economic cycle of change ahead.
Now, the correction and setbacks are here - and in less than 60 hours of trading (10 trading days) - almost the entire perspective has changed.
The morning note this morning would be pages long were I to be able to list all of the lessons being learned over the last 10 days - but I will try to highlight a few:
The "Black Swan" after all was NOT North Korea, Trump antics, DACA, dreamers, the wall, budget arguments, the tax bill, Brexit, or nuclear weapons. It was NOTHING that was in the headline buzzing world we now inhabit.
It was another weapon entirely of our own making. A weapon we had very often warned you of here in these notes - a weapon investors effectively turned on themselves.
Indeed a weapon created by Wall Street morons, which, when reviewed in the light of day during the market autopsy will prove out just as we had defined in those previous references: an investment tool with no purpose or benefit at all and in the end, created only to "find more money to flow through the fee coffers."
Three actually: ETF's, ETN's and passive investing in general. In the end, they worked together to created the very same layered, domino effect which foiled everyone back on October 19th, 1987.
Different time indeed. A different set of numbers. I different starting point of the cascade - but the very same culprit: human emotion...fear.
Let's be clear: almost nothing in economic fundamentals has changed in the last 10 trade sessions.
In fact, most things have gotten better - pause your reading and imagine that lunacy for a moment if you will.
What did happen is the massive mountains of dollars in the active Bond and passive Bond ETF world began to recognize that they were sitting in a pit of their own making (there from fear) and the world was getting better. Slowly, some of them began to sell - and rates rose. Losses mounted - now with most of the sizable bond ETF's having anyone who has invested in them for the last 4 years now entirely underwater on price. As losses mounted, rates rose more and the first dominos tilted over.
The great "vol" trade then came into play. Now, this is something most have never heard of - in fact, it's name even sounds pretty foreign in a world which was supposed to be pretty boring. "Short vol" had taken it's place in the record books of "sure bets" in recent years as volatility in the market lagged and the trend turned steadily upward.
The history of sure bets always ends with dreadful results as there is no sure thing - anywhere, anytime in any "market". Not to fret though - there never has been a sure thing - and the focused, long-term, boring investor has done just fine.
Previous sure bets? Portfolio insurance in 1987. Short yen, long bonds in the summer of 1998. Nothing but tech in 2000. Housing rentals in 2005. Energy stocks in 2008. And yes, the newfound simplicity and all knowing passive investing world of 2016 as the fears of Brexit faded.
This short vol trade has already claimed one entire ETN, done by a big Wall Street bank and more than a few hedge funds - note one from Chicago here. The point?
These crazy vehicles were clearly not even remotely understood by their users. They were designed to short the VIX - the measure of volatility. Apparently the rocket scientists did not figure out in advance that IF the trade ever went wrong - meaning it went against the purpose of buying it - and volatility increased, the way one would offset their losses would be to sell twice as many futures on the S&P 500.
Now, re-read that carefully. And try to follow me here:
The tool supposedly let you "short volatility" and benefit from the upward trend of the market. BUT, and this is a big but - if volatility increased beyond a certain measure (meaning markets would be assumed to be feeling a setback), the response was to short the market more - the same volatility of which you were already short - to cover losses.
Meaning in non-Wall Street Gibberish?
You were pouring gasoline on your own fire.
The result? The next domino.
All the average investors who had been told that passive investing - ETF's - were their answered prayer and all they needed to do was buy a few of these things (holding hundreds, maybe thousands of positions when done). The sales pitch was they would be "reducing their risk" by simply deciding ahead of time how much risk they wanted to take and placing one of those infamous stops either in the market - or worse - a "mental stop" where they would just sell if volatility rose.
This "passive" process somehow gave too many the feeling that they were "safe" and I still do not know why.
The end result: The same basic effect as the dominos we saw in October 1987's "portfolio insurance domino effect."
Evidence of the domino effect and how passive investing fails to keep the real monster at bay:
Now, Lipper has tracked fund flows since 1992. In their words, "It was the worst outflows on record."
"We're seeing a huge flight to safety here, money leaving equities, a lot of money going to money markets," Pat Keon, said senior research analyst for Lipper, in answers to Reuters.
The kicker? Lipper's figures tracked flows up until the week ended February 7, so it's highly likely we will shortly see even larger moves were made on Thursday as the Dow Jones industrial average plummeted more than 1,000 points for a second time in a week.
The dominos now must finish unraveling as the underwater trades of this ridiculous and insanely stupid set of tools gets "unweaved" from the market's cloth.
It will end and the pressure will subside. The forced selling we have seen in the afternoons of late, accelerating aggressively in the last hours or two of trade due to heavy margin calls from these short-vol funds will end. But, not likely before they are toasted and several more funds, created solely for using tools which in the end were of no value - go up in smoke. Their death will be the core reasons for stabilizing this new wave of fear.
Like that verse said we repeated often from the Suncreen Song:
"Don't worry about the future; or worry, but know that worrying is as
effective as trying to solve an algebra equation by chewing bubblegum.
The real troubles in your life are apt to be things that
never crossed your worried mind
...the kind that blindside you at 4pm on some idle Tuesday"
What do I mean? It is never the headlines we fear for months on end which causes the event we are afraid will happen. It is always coming from left field. It rolls through and ends.
The lesson? Stop worrying - stay focused on the long-term horizon.
Worry and fear are the two driving forces which have now - once again - caused the reset we have suggested we pray for hundreds of times. And, it has done precisely what was anticipated.
Read 'em and reap:
10 trade sessions - and we are at 8 on the Fear scale from CNN's sentiment index...8 - meaning only 8 notches down to 0.
In long form:
We are back to Brexit fear levels - the "worst start to a market in 85 years" beginning of 2016 levels and lower than levels seen right at the election in late 2106....all many thousands of points lower from here.
There is more: AAII came in as expected - with nearly 40% of the newly minted bulls when the 2018 year kicked off (just 6 weeks ago) now vanquished:
Recall, the bullish camp was nearly 60% at the start of the year.
That's not all...stocks' internals are reaching levels seen at significant points in the past. Note how few remain above their 50-day moving average:
This chart above is really fascinating to me: The waves of ETF forced selling noted above in outflows, have pushed a massive number of stocks down (just as we warned of their mechanics of an ETF which many still do not understand) below their 50-day moving average.
Note carefully just how wide-spread the forced selling has been due the nature of the ETF's. The red arrows show you we have only seen these levels a few times before:
...all the way back to the end of the tech bubble
...the pit of the 2008/2009 Great Recession
...election fears in 2016
Think carefully here - looking forward from those points - were they good times or bad times to be an owner of equities?
One More Lesson
Before ETF's, when you got fearful, you called your broker and sold your single stocks and/or funds. At worst, your fund manager was then forced to sell some of his stocks to raise the cash for your liquidation.
Today, when the audience goes to sell their ETF's out of that same fear (use SPY as an example) you are selling some of all 500 stocks in the Index. Indiscriminately - cased on zero fundamental issue - only on fear and the desire to be "out".
Carry that further and you will begin to understand the nasty underbelly of Wall Street. If I am sitting at some hedge fund and I know exactly what is in an ETF and I know exactly what people do whey they are afraid - then I will know precisely which stocks will be weakened as that order flow explodes - just as we have witnessed in the last 10 days.
Now, further - If I am a real moron - my brain can temporarily detach from my morals and I can go to my boss and say, "Hey Boss, you know we can build an algo that will track that order flow and when we see it coming from the ETF or ETN pressure, we can sell into it and push on the short side..adding fuel to the fire and causing more selling. Then we just cover when the panic recedes."
Friends, that is a FAR, FAR, FAR different world when you enter the "passive investing" of ETF's.
The Ultimate Lunacy?
The earnings season, new benefits coming from the tax bill and the expansive investing from repatriation have not even been a) fully measured yet or b) evn felt in the economy.
As such, this ETF/ETN driven charade has overwhelmed was was 10 days ago - a very positive back-drop. Here is the latest on just how positive:
The chart above is from Zacks and show the steadily increasing numbers as the Q4 17 data gets announced and the benefits of tax changes on the forward looking bottom line is added up.
The growth rate expected in 2018 going forward for the S&P 500 (yes the same stocks now suffering forced selling from ETF's gone wild) is over 19%. That growth rate has not been registered since 1982.
The chart below shows the quarterly rolling rate going forward:
Time for one more?
Manufacturing and services are just great too:
Let's first look at the readings - then note the comments from the filing itself - always somewhat insightful:
So, in the end of this lesson of the last two weeks - and the extreme values created in the market - (but ONLY for those who can remain focused on the long-term trends and forces underway), one is left with a simple set of thoughts:
Do I go with the earnings evidence, the fundamental readings, the packed jobs markets, the record incomes, the $11 Trillion still in the bank? ....or
Do I go with the dumb-ass morons who have once again created something that really does nothing in the end but cause strife, fear, stress, short-term disconnects from reality and more fees - having nothing at all to do with investment values?
Something worthy of pondering over the weekend I suspect.
The prayed for correction is here.
This will sound completely nutty - but be grateful for it.
Demogronomics keeps you on the leading edge of change but there is a cost: it requires a much larger, more patient and disciplined view of the elements at work.
It's the long-term currents we need to invest upon - not the short-term waves which will assuredly always roll ashore to block the horizon - just as they are now, causing doubt in the minds of millions once again.
Those waves are the noise too many will likely continue to be lost in...and the reason the long-term game is so hard to win based on fearful activities.
Play it Again Sam....
In the end, like it or not, long-term investors have learned this:
Demographics Rule The Long-Term Game
Until we see you again - may your journey be grand and your legacy significant.