Exposing ETF-Induced Market Socialism

Grizzle.com’s Chris Woods fears that so-called ‘wage growth’ has unsettled the ‘Goldilocks’ market era.

The stock market’s biggest correction since Feb 2016 was – according to the common narrative – triggered by one strong wage number.

This has raised concerns that the era of ‘goldilocks’ may be ending where growth has been neither ‘too hot’ nor ‘too cold’, allowing interest rates to remain at the ultra-low levels that have prevailed since the financial crisis.

But Woods warns of the increasing homogeneity of modern markets (in addition to the dominance of algo-driven momo-trading machines): If a strong wage print has been the trigger for falling share prices, there has also been evidence in the past week of machine-driven selling accentuating the decline.

One interesting point about the sell-off is the way volatility has surged in an American stock market which has become dominated in recent years by machine-driven “algo” trading and related passive investment strategies or pseudo passive strategies otherwise known as “smart beta”.

Such passive investment strategies, also known as “indexation”, involve investors buying indices as opposed to individual stocks, a trend further encouraged by the explosive growth in recent years of exchange traded funds (ETFs). Net issuance of US domestic-equity ETFs has risen from US$38.5bn in 2010 to US$186bn in 2017, while assets of domestic-equity ETFs have surged by an annualised 23% over the same period to US$1.98tn at the end of 2017.

And as Woods indicates ominously, the commoditisation of equity investment represented by ETFs, and the related illusion of liquidity that results, further accentuates this risk.

It is further the case that the indexation trend ultimately amounts to a form of investor socialism. This is because more and more money flows into products mirroring the same index, such as the S&P500. This means everybody is buying the same stocks.

This ultimately makes no sense since valuations become super extended…for the ‘average worker’

which is why the S&P500 was trading at an all-time high price to sales ratio before the correction.

This is why socialism makes no more sense in investing than in real life.

Woods also points out some awkward similarities to a much more concerning year…

The other point about the October 1987 crash, which has real relevance today, is that the sell-off was in some respects mechanical in the sense that it was exacerbated by an unwind of so-called “portfolio insurance”, a popular investment strategy at that time. The same risk is repeated today, albeit on a dramatically larger scale, by the dominance of machine-driven trading in an American stock market where machines are estimated to account for as much as 80% of daily stock market trading.

This creates the risk that, when a correction does happen, it will feed on itself in a negative feedback loop. For given that the machines are all probably programmed with the same momentum investing formula, the risk is that a trend change is exacerbated on the downside.

Read more here…

via Zero Hedge http://ift.tt/2EYXRP6 Tyler Durden

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