Did You See The Fireworks On Friday?
As the volatile week wrapped up, something very unusual happened on Friday; something that has only happened 0.17% of the time since the inception of the Russell 2000 ETF, IWM. The S&P 500 closed 1% higher while the Russell 2000 closed negative. This is just the sixth time since May 2000 we have seen such an event.
Before we get into the details, it’s important to point out that it is hard to rely on such a minuscule sample size. Furthermore, one of these occasions happened the day before 9/11, which shut down the stock exchange for a week. With that being said, since this is such a rare occurrence and the results are fairly dramatic, I want to share with you the short-term performance following these unusual days.
The average daily change for the S&P 500 one day later is -2.7%, roughly a negative 2.5 standard deviation event from the average daily return of 0.03% going back to 1950. Even if you eliminate the results from 9/11 and the post Lehman period, ‘01, ‘09 and ‘10 still showed pretty significant results with S&P 500 returns one week later being -4.73%, 4.18% and 5.05% respectively.
Bottom line, don’t be surprised to see the wild swings from the past few weeks continue into the next week of trading.
Photo by KB
Where The Money Flowed Last Week
What people say often lies in stark contrast to what they do, especially when it comes to investing. That’s why I like to look at where money is going, especially after some volatility has been reintroduced into the market.
I don’t necessarily think there is anything in these numbers that can provide an edge, I just find it fascinating to watch where investors are putting money to work, and where that money is coming from. Blackrock puts out a weekly piece and I’m going to share some nuggets that I found particularly interesting.
10-year yields declined by more than 15 bps last week, the largest weekly move since last August. IEF- the 7-10 year treasury fund saw the largest fixed income flows on the week. The high-yield space, represented by HYG and JNK combined for over $2bn of trading volume on Friday for the first time ever.
EEM short interest has risen to a 5-month high and has seen outflows three of the last four weeks. This is after logging fifteen prior weeks of consecutive inflows. The strong dollar has certainly been a headwind to this space.
The United Kingdom ETF, EWU, lost 12.3% of its assets and European ETFs as a whole logged $1.8bn of outflows. Interestingly, the largest single country inflow was Germany, which lost another 4.8% last week on lousy economic data and is officially in bear market territory, 20% off its highs.
Biotechs have been one of the strongest areas over the last several years and IBB had a strong week of inflows. The cap-weighted ETF logged $498mm of inflows, adding almost 10% to its AUM. Buy-the-dippers got burned as it lost 5.3% on the week. From the open on Monday to this morning’s lows, it was down another 4.3%.
Investors poured money into Coke and Pepsi and ripped money out of Amazon and Disney, classic risk off behavior. XLP had $469mm of inflows while XLY had $614mm of outflows.
After the worst 3-day stretch since 2011, I’m excited to see what rational investors are doing this week.
Navigating The Pullback
If when the S&P 500 closes below $1910.79, the large caps will have experienced their thirteenth 5% draw-down, on a closing basis. The problem investors and traders run into when faced with draw downs- i.e. when the value of your portfolio is going down, is that we have no way of knowing when the bleeding will stop. Over reactions and hyperbole are ubiquitous; it’s as if a 5% correction somehow makes us rethink everything we thought we knew about the stock market.
To keep this in perspective, since 1928, we have averaged three 5% corrections a year. Should another 5% correction trigger, this would be just the third time since November 2012. The average of these 12 draw downs has been 8.6%, so if history is any guide, we have a few percent to go before this is all over.
However, history isn’t any guide. When faced with stress, we’re incapable of leaning on the data. And I get it, I’m not pointing at you as if I’m somehow immune. As I’ve confessed before, I’m fearful when others are fearful.
So how do we know for sure that this isn’t going to get much worse? With the Fed exiting and the mess over in Europe and collapsing commodities and the surging dollar and ebola and Russian sanctions, things are pretty scary out there.
But the truth of the matter is, for your portfolio, none of these are the canary in the coal mine, you are.
Having a plan is the only thing we can control. If you are a trader, trade, if you are a buyer and holder, hold, if you have a diversified portfolio, rebalance.
Risking money in the markets without a plan will have devastating consequences for your portfolio. If you’re selling stocks this morning, either you’re a lousy trader or a scared investor. Either way, let this be a learning lesson. Volatile markets are always good times for us to take a step back and evaluate if how we’re investing meshes with our ability to handle risk and cope with inevitable drops in our portfolios.
Be Careful Shorting the Russell 2000
Yesterday I pointed to the elevated volatility and lower expected returns that are exhibited when the Russell 2000 is below it’s 200-day moving average.
It stands to reason that if being long small-cap stocks below the 200-day moving average is dangerous, surely being short under the 200-day can be extremely lucrative right? Wrong!
The problem with shorting in down trends is that is where we experience the most vicious rallies. Since 2000, there have been 46 instances where the Russell 2000 gained 4% in a single day, with an average return of 5.5%. Forty-one of them, or eighty-nine percent of those days occurred when stocks were below the 200-day.
Here’s the bottom line: navigating through the Russell 2000 when it is below the 200-day is not for the faint of heart. Today’s 1.92% gain, much to the chagrin of shorts, is fairly common. Hopefully this data helps the next time you consider shorting stocks because they’re in a down trend.
Small Caps Are In The Danger Zone
Today I want to bring some data to one of the simplest tools a technical analyst has at his/her disposal, the 200-day moving average. This line shows us a big picture view of how a security is behaving. Simply put, a rising 200-day moving average is indicative of an uptrend, a flat moving average shows no clear trend and a declining moving average indicates sellers are in control.
Currently, for the first time since November 2012, the 200-day moving average for the Russell 2000 is declining and small-caps are now firmly below the 200-day moving average.
"So we’re below an imaginary line, so what?"
Well, I looked at the data going back to 2000 and whether or not you’re a believer in technical analysis is irrelevant, the data speaks for itself.
1) The average daily return when the Russell 2000 is above its 200-day moving average is 0.13% vs. -0.15% when it’s below.
2) Volatility, as measured by standard deviation is basically half when small-caps are above their 200-day vs. when they are below.
3) There have been 33 instances where the Russell 2000 fell 4% in a single day when trading below the 200-day vs. only 4 occasions when trading above.
Mid-caps are also below their 200-day for the first time in 23 months and the S&P 500, which hasn’t seen this level since November 2012 is now just 1.5% away. While this doesn’t mean stocks crash, it does mean that we can expect some elevated volatility and subpar returns until stocks can reclaim their 200-day and push it higher.
Thursday was an ugly day for the markets. In stark contrast to the recent rally that’s been lacking broad participation, virtually everything participated in Thursday’s washout. My friend Jon Krinsky notes that 94% of NYSE composite volume was in declining stocks, which was the highest reading since February 3rd.
You can make the case that this extreme selling in a bull market that is just a few percent off the highs pours water on the argument that people are gaga over stocks. Despite the fact that buying every dip has worked for the last few years, anecdotally, I didn’t see many vocal bulls yesterday. I did see a lot of people who were of the mind that this one “felt different” (Full disclosure, I’m fearful when others are fearful, I was not in there buying on Thursday).
It’s way too early to know if the bounce we saw today is the end of the correction, but if it was, only in a hated bull market is it possible that we can bottom when the Dow and S&P 500 were just 2% and 2.6% respectively off their all-time highs.
As I discussed last week, the indices are often not indicative of what is going on with the majority of stocks. The truth is, stocks have been in a correction of sorts for a few weeks now. Krinsky notes that earlier in the week, just 34% of Russell 2000 stocks were above their 200-day moving average, the lowest number since 2011. Furthermore, Jon notes, last Friday, the Russell 3,000 made a new 52-week high while less than 55% of the constituents closed above their 200-day moving average, a phenomenon that has not occurred since March of 2,000.
Again, it’s way too early to declare that a durable bottom is in, the point is that the market has been correcting for a few weeks, it’s just been kept a secret from the public, until yesterday.
Photo by Jim
About That Death Cross
There has been a lot of talk the last few days about the Death Cross in the Russell 2000. This is a technical term for when the 50-day moving average crosses below the 200-day moving average. The story goes that this is bad news and traders should pay close attention.
This sounds good and makes sense intuitively, however, the recent data does not support this claim.
Going back to 2000, there have been nine instances where the 50-day moving average fell below the 200-day moving average. The average and median return going out one year are 11% and 15% respectively, not exactly bearish.
The most bearish data point I could find to support the validity of the Death Cross is that of the five instances that the Death Cross occurred when the 200-day moving average was not rising, the returns just one week later were -7.15%. However, the returns 3, 6, and 12 months later were better when the 200-day was not rising versus the Death Cross in a rising 200-day environment, go figure.
Taking this a step further, I wanted to examine the “Golden Cross,” which is the exact opposite, when the 50-day moving average pierces the 200-day from below. This, as the story goes is bullish for stocks. Once again, the data pokes a hole in the story. Going back to 2000, there have been 10 registered Golden Crosses in the Russell 2000. Just as you might suspect, the results for the Death Cross trounced the results that were produced by the Golden Cross; the average and median return one year later is 7.5% and 3.6%, 32% and 76% lower than the results produced from the Death Cross!
I’ve heard technicians dismiss these indicators as bunk, so I wasn’t shocked to see that the death cross was not indicative of anything. However, I was shocked, as I’m sure you are, that the Death Cross is more bullish for stocks than the Golden Cross.
The Market is Preparing For Rising Rates
The prospect of rising rates has been the most widely talked about topic among market participants for the last year. Fed language is being scrutinized and dissected like maybe no other time in market history. It has been fascinating to witness;all the while we were told to prepare our portfolios for rising rates and to the chagrin of many, yields have done nothing but fall.
Today, in lieu of conjecture, I want to point your attention to the facts. As the 5-year treasury note yields hit their highest levels since May 2011, the XLF/XLU ratio is up over 2% and is having the fourth largest daily increase of 2014.
This is something worth paying attention to because these sectors are both very sensitive to interest rates, albeit in different ways. In theory banks should benefit from rising rates while utilities and their bond like characteristics benefit from falling rates.
I’m not concerned with what people say, I’m more interested in what they do. Today we are seeing signs that market particpants are starting to prepare for rising rates, I’ll be watching these sectors closely.
Big Returns, Big Volatility
Tesla has returned almost 1,500% since the IPO in 2010, compounding at 72% per year. The S&P 500 has returned 85% over the same time, compounding at “just” 13% per year.
Today, as Tesla is down 10%, it’s a good reminder that with individual stocks, above average returns comes with above average volatility.
Tesla has had 140 sessions where the stock was down at least 3%, or roughly one out of every seven sessions. For some context. that has only happened on six occasions for the S&P 500 over the same time, or one out of every one hundred and seventy-six days.
I hate to be the bearer of bad news, but ‘d argue that achieving these returns is virtually impossible for most investors. As a stock exhibits parabolic rise, a few things happen:
1) It becomes an increasingly large percentage of your overall portfolio.
2) As the size of the position grows larger, you become more sensitive to the huge dollar swings.
3) You expect the meteoric rise to continue indefinitely
If you’re investing in a growth company that you think is going to change the world, you very well may achieve out sized returns, but be prepared for out sized volatility..
Photo by Gary
According to the World Gold Council, the first gold coin was struck around 500 BC. Twenty-five hundred years later, at ~$2.4T, gold is larger than all European sovereign debt markets.
So I guess the obvious question is, can a market of this size be manipulated? I’m not sure, but gold manipulation is a tale as old as time and where there’s smoke there’s fire. Below check out the fire which comes from Benn Steil’s “The Battle of Bretton Woods.”
"From his bed each morning, Roosevelt would, after briefly conferring with his advisers, set a daily target for bumping up the gold price, not always through scientific methods. One day, November 3, the president suggested that gold should go up twenty-one cents. "It’s a lucky number," he explained, chuckling, "because it’s three times seven."
"If anybody ever knew how we really set the gold price through a combination of luck numbers, etc.," observed Morgenthau, I think they would be frightened."
Obviously a lot has changed since the 1930’s but there are still people who insist that gold is manipulated (usually when it’s down). Just Google “gold manipulation” and you’ll see 11.2 million results. I’m not qualified to have an opinion on the matter but the quotes above certainly make the case that gold once was heavily manipulated.
Photo by Lawrence Chard