As you know, I turn to cash when the market momentum turns negative. That’s been a pretty boring few weeks from the sideline. But looking at this chart – below – I need to explain what happened this week.
We witnessed a classic, hedge fund-driven selloff fueled by small one-day or several-hour pops, followed by a strong fade after stocks hit their resistance levels. In the case of the S&P 500, the market has struggled two straight days to surpass support at 4,590.
We’re not seeing buyers enter the market at these support levels, fueling a round of selling by institutions and other big funds as they try to exit positions.
Meanwhile, we’re watching volatility spike over and over again after slight pullbacks. This signals to me that there might be a bigger issue at hand. And that issue is margin calls.
Remember, funds are able to effectively borrow capital and then leverage that money to amplify their returns. But when selling starts and lenders start to worry about their capital, they can call margin and demand the return of that money.
Margin calls can fuel big drops in the market. The reason: People who are borrowing might need to sell other assets in order to satisfy their capital requirement. They might have to sell stable investments or stocks that don’t face much volatility, leading to an even bigger drop in the broader markets.
Here’s Why Things Are Even Trickier: FNGD
I’m looking at something called the Bank of Montreal MicroSectors FANG Index 3X Inverse Leveraged ETN (NYSE:FNGD). Ever heard of it? No? That’s by design.
If you think the UVXY – which is a leveraged volatility product that only goes up over many days when market momentum is negative – is complicated, imagine the FNGD as the final boss of a very difficult video game.
This is a 3X-inverse leveraged product tracking exchange-traded notes. Yeah, this is the sort of thing that should never be touched by any rational man.
But this appears to offer some clues into capital outflows of senior debt in some of the biggest technology companies in the market. This product has decayed in value constantly during bull markets. The reason is simple: everyone likes to pour money into the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google).
But the FNGD – which tracks outflows of these stocks – has fallen off a cliff over the last year. It makes sense when you see how much money has poured into those mega-cap tech stocks.
Every now and then, when the markets are really in disarray, we start to see this thing take off. It moved 16.75% over the last week, with the bulk of the move happening on Friday (up 12.5% with 30 minutes left in the day).
During April’s negative momentum move, it popped 50%. At the onset of the February 2021 turmoil, it ripped more than 60%. It more than doubled during the March 2020 crash.
The point is – hell’s usually breaking loose when this thing is on the move. You’ll want to see it fall sharply over several days as volatility cools before you bring in cash off the sidelines.
This isn’t something that you want to invest in. But it’s something that YOU HAVE TO WATCH. Capital flows out of mega-cap stocks should be very concerning, and we need to watch where that money is moving.
My guess right now is fixed income, even if it’s offering a negative return right now. Institutions appear more focused on wealth preservation than accumulation in this time of uncertainty. Remember, cash is your best friend right now.