Headline Risk Says Trade the Fundamental Gravity

09/23/2020 10:01 am EST

Focus: STRATEGIES

Landon Whaley

Editor, Gravitational Edge

Headline risks are everywhere, and as an investor, you must keep your head on a swivel and human reactions in check so that you’re not drawn into well-written narratives that promise to unveil the mystery of financial markets, suggests Landon Whaley of Whaley Global Research.

This week’s headline risk comes courtesy of the ETF (exchange-traded fund) industry, which has exploded since the first one, the SPDR S&P 500 ETF Trust (SPY), began trading in January 1993.

The popularity of these vehicles has reached new heights recently because investors are fed up with the mediocre performance of active managers. In the last few years alone, investors have plowed almost $3T into passive funds while yanking over $1T from active ones.

Who can blame them?

Most active managers have failed to earn even decent returns in one of the longest bull markets we’ve ever experienced. Economically, the decade from 2010 to 2019 was one of the US’s lengthiest non-recessionary stretches. If you can’t earn reasonable returns in this type of environment, why should investors continue to pay management fees year after year?

This insatiable appetite for passive investing has encouraged ETF creators to go far beyond merely allowing investors to mirror the returns of the S&P 500. ETFs enable investors to gain exposure to everything from commodities like crude oil (DBO) to more esoteric strategies like merger arbitrage (MNA).

Further evidence of the ETF industry going too far surfaced when the ETF Industry Exposure & Financial Services ETF (TETF) began trading in April 2017. This ETF comprises companies that are “driving and participating in the growth of the exchange-traded funds industry.” An ETF of ETFs?! Are you kidding me? You’ll be shocked to learn that TETF only made it 24 months before shutting its doors. 

Doing Too Much

Speaking of ETFs that are more marketing ploy than investment strategy, enter the Direxion Fallen Knives ETF (NIFE). This new ETF, which began trading in June, mimics the Indxx US Fallen Knives Index comprised of “stocks that have fallen precipitously but could be primed for big rebounds.”

Direct from Direxion, “Fallen knives may offer the opportunity for outperformance within an equity allocation. Screening for eligible names that have recently experienced substantial negative returns helps identify differentiated exposure.”

The real problem with this type of fund is that often, stocks get monkey-hammered because of the prevailing fundamental gravity. If that’s the case, those stocks will not be “primed for big rebounds” until the economy shifts into an FG environment that is once again bullish for those particular stocks.

Not only are retail investors using ETFs to catch falling knives financially, but according to Bloomberg, they are using ETFs to lever-up and buy high-flying stocks.

Leverage is a Four-Letter Word

Fund-flow data tells us that investors are gobbling up the 3x levered Nasdaq ETF (TQQQ) at a 1999-inspired pace. In the past eight trading days alone, this ETF has seen inflows of more than $1.5B, which is the most since 2010. This levered fund has now traded more in the last month, the three of the largest and most actively traded ETFs (GLD, LQD, EEM) on earth, combined!

Not only that, but millennials are on TikTok advocating for these levered ETFs and describing them as doing “the exact same thing as the market…but three times faster.”

Folks, I couldn’t make this guano up if I tried! I’ll bet you a double sawbuck that these 12-year olds with lumberjack beards are going to find out the hard way: levered ETFs may go up “three times faster” than the market, but they also fall with the same velocity.

The Bottom Line

The headline risk bottom line is that it doesn’t matter if you invest in Catholic values, eSports, or gurus; if you trade in opposition to the underlying FG, your portfolio is going to get the Buffalo Bill treatment. No matter your investing interests or approach, only consider investing in ETFs with sector exposure concentrated in favorable sectors for the prevailing fundamental gravity.

To learn more about Landon Whaley, please visit WhaleyGlobalResearch.com.

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