We are officially in early voting season across the United States. While political polls dominate the evening news, another set of ballots was just cast that tells us far more about our economic reality.
As a technician, I came to realize a long time ago that markets move more on asset flows than pure fundamentals.
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So in times like these, a rocky market’s future might be as simple as seeing where the money is going. Let’s have a look.
Between Oct. 12-16, investors “early voted” with tens of billions of dollars across the ETF landscape. And it seems to me that many are voting out of habit, while the market is rewarding something entirely different.
When in doubt, retail and institutional investors alike default to the incumbent. In this case, the incumbent is equities. Despite a harsh week in the stock market, the Pavlovian reflex to “buy the dip” remains unbroken.
The Invesco QQQ Trust (QQQ) topped the weekly inflow rankings, pulling in a giant $4.71 billion. Even as the ETF fell 5.5% on the week. Investors chase performance. But as I’ve noted before, the “passive flow” from 401(k) plans and the like provide an automatic inflow to funds like QQQ and these S&P 500 ($SPX) trackers:
SPDR S&P 500 ETF Trust (SPY): $4.1 billion SPDR Portfolio S&P 500 ETF (SPYM): $4.0 billion Vanguard S&P 500 ETF (VOO): $3.9 billionThis is the financial equivalent of voting for a single party down the ballot. Investors have been conditioned over the last 15 years to view any 5% pullback as a guaranteed buying opportunity.
“Buy the dip” is so ingrained in modern investor behavior, it will take more than the worst week since June to break it.
While passive equity grabbed its usual headlines, the fixed-income and small-cap markets delivered a vote of no confidence regarding a return to the “cheap money” era. Specifically, the iShares 20+ Year Treasury Bond ETF (TLT) suffered the market’s largest withdrawals, bleeding $2.99 billion in just five days. Given this picture over the past four months, perhaps too little, too late.
www.barchart.com The iShares Russell 2000 ETF (IWM), which desperately needs lower borrowing costs to support debt-heavy small caps, followed close behind with $1.20 billion in outflows. And when I stare at this chart, day after day, all I can think of to describe it is “sad.”
www.barchart.com This looks to me like an asset class that is in secular decline. The evidence is building. A whole generation of investors have grown up on S&P 500 and tech stocks. Smaller companies with debt overhang are not catching the contrarian buyers they used to due to higher borrowing costs.
IWM sells at around 18x trailing earnings. I’m no fundamental analyst, but if I had to guess at what P/E ratio these might fetch more bids, I’m thinking below 10x. It really is not too difficult to imagine, when you see a longer-term chart. Here it is, with my pointing to where a more-than-40% decline could land IWM.
www.barchart.com I never assume. But with this type of downside risk, small-cap ETFs that short the index like the ProShares Short Russell 2000 ETF (RWM) or the Direxion Daily Small Cap Bear 3X ETF (TZA) are more attractive than IWM would be.
Rejecting the Fringe Candidates
If mega-cap tech was the incumbent retaining its seat, the speculative fringe of the market was forcefully voted out of office. The performance laggards board looked like a 20% massacre of the market’s most hyped narratives. Oh, these have already caught a bounce. But the prevailing trend appears to be lower for now. I’ll also note that several of these are newer ETFs, which speaks to the late-stage nature of the AI stock rally.
Virtus Cloud Computing ETF (NCLD): -23.7% Valkyrie Bitcoin Miners ETF (WGMI): -21.9% Global X Cloud Computing ETF (GCPU): -21.5% Roundhill MEME ETF (MEME): -21.2% Defiance Quantum ETF (LYTE): -19.9% Spear Alpha ETF (SPRX): -19.8%The Write-In Winners: Real Assets and Volatility
So, if speculative tech cratered and long bonds were abandoned, what actually won the week? The protest votes!
Capital migrated aggressively to oil and volatility. In the case of the latter, it was like the dead reawakened. I was starting to think the CBOE Volatility Index ($VIX) was asleep. And given that ETFs like the ProShares VIX Short-Term Futures ETF (VIXY) are about as close as we get to owning S&P 500 put options in ETF form, that’s good to see.
Short-Term Volatility (VIXY): +8.9% United States Oil Fund (USO): +8.9% Broad Energy / Commodities (WTIB) (DBO): +8.3% and +7.5% European Defense (WDEF) (XDEF): +8.1% and +7.4%
www.barchart.com Lastly, above is USO, a popular oil price ETF that also has a popular options market around it. If there’s a current classic case of Warren Buffett’s “three desk trays: in, out and too tough,” this is in the last category. Volatile war headlines and investing profitably are like, dare I say, oil and water.
ETF flows are helpful, but not essential. At times like these, I think the best use of them is for monitoring, not big decision-making. But if we do continue to see gradual bleeding in small caps, that’s a confirmation of what the charts and the reality of higher rates are indicating.
As for the bull market, one led exclusively by the biggest stocks, here’s the key to keep in mind. If those S&P 500 funds start to see net redemptions for several weeks, that could be THE signal that the stock market is not resting. It is preparing to crash.
Rob Isbitts is a semi-retired CIO, former fiduciary investment advisor, Barchart columnist, and straight-talker. Download his new free e-book on hedged bond investing for retirement at ETFYourself.com. His research and model portfolios are at ROAR.PiTrade.com.
On the date of publication, Rob Isbitts did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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