Shorten Your Investment Horizons, and Then Hang Tight
* We are all traders now!
"ETF's are a great innovation, but an over-population of any innovation could cause unintended consequences if left unmonitored. We have seen this in many market cycles, from dot-com to the credit crisis ... This time won't be different."
--Troy Draizen, head of electronic trading at Convergex Execution Solutions
In Wednesday's opening missive, "The Bull Won't Die Easily," I gave a lengthy explanation why, even though the market's complexion is clearly changing, I am not short and why I am maintaining a market-neutral position. (The day before, in "Feeling the Market's Pain," I basically wrote on the same theme).
I see several conditions -- including a resumption of an interest rate rise after a possiblebuying climax in bonds earlier in the week, a market-friendly outcome in the French election, and some improvement in hard economic data -- that could lead to a modest near-term advance in equities and make short positions uncomfortable.
At the same time, I have continued to express profoundly deep intermediate-term market concerns, yesterday adding a concern regarding the proliferation and growing popularity of exchange- traded funds in "This Ain't No Seder - I Now Have Eight Questions!" I continue to plan to short a rally.
So, I am neutral over the near term, awaiting some confirmation of my concerns about a market price breakdown in order to move back to the dark side and bearish beyond the next month or so.
Back to the Structural Risks, Which Likely Will Be Brought on by ETFs
As mentioned earlier, the virtual explosion in exchange-traded funds led me to ask yesterday, " If ETFs sell, who is there to buy?"
We all must recognize that when the market moves in a northerly direction the potential structural issues and emerging market inefficiencies are camouflaged by the rising tide of higher stocks. But when, inevitably, the tide retreats and stocks fall, we may re-run the movie of October 1987 in Portfolio Insurance Act II.
Speaking of ETFs, there are two Zero Hedge articles that must be read regarding the risks associated with exchange-traded funds; they are here and here (the latter more of a discussion of the Market Vectors Junior Gold Miners ETF (GDXJ) fiasco).
Of course, aiding and abetting the ETFs and causing more market artificiality -- and failure of price discovery -- is the other dominant investor these days: quant funds (risk-parity and volatility-trending strategies) that worship at the altar of price momentum.
These two investors (ETFs and the machines) coupled with seven years of unprecdented central bankers monetary largesse that has suppressed volatility are important contributing factors why hedge funds are dropping like flies over the last 12 months.
Finally here (again, hat tip to Zero Hedge) are some sober comments from hedge fund manager Richard Breslow that should be carefully read and that help to further explain the binary nature of our markets, why traders are getting chopped up, the widespread closures of some long-term-oriented high-profile hedge funds and the broad confusion in the interpretation of events on the markets (boldface sentences are my emphasis):
"We've all been going through a period of re-evaluation. Not personally focused, to be sure. No evidence of self-doubt from any quarter. And never have people been more convinced that they can size up the next person within a matter of seconds. But there's been plenty, and rapid, rethinks on what is, and should be, driving markets.
Is the economy running hot or catching a cold? Reflation: yes or no. Just what is the state of global trade? Fiscal policy in or out? Does it matter? And on and on. For big ticket items galore, that are meant to have long-term implications. And given that world views are changing back and forth in quick succession, investing has been infused with an unhealthy dose of manic emotion, at the expense of dispassionate analysis.
And then throw in the fact that even if gifted with perfect knowledge of how supposedly binary events will be decided, no one has been getting the actual market implications right.
All of which means traders have been getting crucified when trying to express long-term views. And undisciplined practitioners carried out on their shields. It's unpleasant to be serially stopped-out, but this is no environment to have a view without explicit parameters.
So at the risk of getting chopped up further, with all of the revolving zeitgeists and political risks, it pays to try to figure out asset price levels where you think emotions will swing rather than where traditional methods would suggest you are right or wrong. And for better or for worse, in today's milieu, passion can be quick to come by.
For all of the flying, crashing, rinse repeating, the S&P 500 has essentially done nothing for a couple of months. But I'd be willing to bet that a close below 2320 or above 2380 will get lots of people passionately excited. Depending on your view, they are both close enough for anyone to afford.
The dollar index has shown a propensity, when it ran up and as its come off, of higher highs, higher lows, and the reverse. A close below 98.85 or above 101.30 will probably do the trick here. I could have tightened these up a bit, but it's been a really messy trade and still cheap.
Treasury levels have been so rehashed, that you should already know them.
In any case, take a look at your charts and decide where you think emotions will swing and short-term momentum kick in for a trade."
In other words, today's investment world is all twisted around by a number of new and structural influences.
For now, investment horizons should be close and shortened.
We are all traders now.