For the last few months, we have repeatedly warned about the mounting risks which were being ignored by an increasingly overly complacent, overly exuberant market. Doug Kass had a good compilation of those concerns on Friday:
Of course, the sell-off last week was simply more evidence of the influence of “algos gone wild” when technical levels are broken and the robots all hit the “sell” button at the same time. It was also further acknowledgment of the lack of liquidity due to the surge in ETF issuance which has now created a massive amount of overlap risk in the markets.
“When the market goes down, passive fund managers will be forced to sell stocks in order to track the index. This selling will force the market down further and force more selling by the passive managers. This dynamic will feed on itself and accelerate the market crash.” – James Rickards
The same was noted by portfolio manager Frank Holmes as well:
“Nevertheless, the seismic shift into indexing has come with some unexpected consequences, including price distortion. This isn’t just the second largest bubble of the past four decades. E-commerce is also vastly overrepresented in equity indices, meaning extraordinary amounts of money are flowing into a very small number of stocks relative to the broader market. Apple alone is featured in almost 210 indices, according to Vincent Deluard, macro-strategist at INTL FCStone.
If there’s a rush to the exit, in other words, the selloff would cut through a significant swath of index investors unawares.“ – Frank Holmes