What’s the lesson I learn and forget?
It’s that the market can do absolutely anything. It doesn’t have to ‘make sense’. Its role is to inflict pain on everyone — both the emotional and the rational investor — at some point.
Right now, it’s inflicting pain on the cautious, rational investor. In an economy devastated by fear-mongering politicians, who see lockdowns and ‘protecting citizens’ as vote winners, it seems strange that stocks are soaring.
Well, in Australia, the market itself isn’t soaring. Thanks to our exposure to banks and big resources (whose share price peaked back in mid-2019), the benchmark index is still well below its highs from earlier this year.
But look under the surface, and there is a raging bull market going on.
Australia’s flagship tech stock, Afterpay Ltd [ASX:APT] recently soared to fresh new highs. In fact, the Aussie tech index (thanks to its largest constituent) is at all-time highs, as you can see in the chart below:
Is it rational to be buying here? Or are price moves irrational. Only the market will tell us the answer to that in due time.
Volatility is about to pick up again…
For what it’s worth, here’s my view on how to minimise pain:
Take a position based on rational analysis. If you’re right, the market will soon reward you for it. But if you want to make big gains, you have to wait for the emotional, FOMO momentum traders to jump on board.
The rational investor will want to head for the exits as soon as they do. But that would be a mistake. There is a lot of potential upside in the momentum trade. The trick is to be rationally irrational about it.
Mind you, it’s not easy to do. Most investors are either consciously rational or unconsciously irrational. Occupying that middle space take discipline.
Which is why I’m fascinated with the NASDAQ right now. From the outside looking in, it’s dominated by irrational investors. Valuations are absurd. But no doubt there are lots of big money managers with a rational brain just riding the momentum.
I wonder if they’re getting increasingly nervous though?
There are a few indications that volatility is about to pick up again.
Check out this story, from the New York Post:
‘The colorful Japanese billionaire behind the summer’s unexpected tech rally — and subsequent declines — appears to be up to his old tricks.
‘Masayoshi Son, the 63-year-old founder and CEO of SoftBank, was unmasked as the so-called “Nasdaq Whale” in early September after it was revealed that he plunked down billions to buy options in popular tech stocks like Amazon, Alphabet, Microsoft and Tesla during the COVID market crash. Son’s buying spree — funded by both Softbank and his own pocket — is believed to have helped push the Nasdaq up 60 percent between April and September — contributing to a bubble that came tumbling down at summer’s end.
‘Now traders say they are seeing a familiar pattern in options trading that suggests the Nasdaq Whale is back and raising fears that tech investors could be in for another big hangover.’
What does this mean?
We’re moving into the era of the ‘stock picker’
Well, the huge amount of option buying means the sellers of those options must hedge themselves, which they do at least in part by buying the NASDAQ. This leads to a huge amount of money flowing into tech stocks (via investment in the index) which in turn attracts the retail FOMO investor.
The QQQ ETF tracks the performance of the NASDAQ index. It is now the largest index in the world. Zero Hedge reports:
‘According to Bloomberg’s calculations, the$146BN QQQ ETF, the largest tech ETF in the world, has seen a staggering $1.5 billion in daily flows (either in or out) over the past month, following the previously discussed largest withdrawal in two decades in late September, followed by its largest influx in the same time period one day later. The ETF saw $3 billion of inflows the following week, ahead of a $3 billion exit the next day. This week brought another $3.7 billion inflow in a single day.
‘The startling spike in the size of flows is clearly visible in the chart below, where the new “regime” is highlighted in yellow…
‘One possible explanation is that the recent surge in retail option trading has left the ETF as a hedging vehicle, while some say that renewed appetite among retail investors is fueling the flows. Others speculate that the cash churn amounts to a massive tug-of-war over the outlook for technology shares, which have staged a remarkable 73% rally since the March lows.’
My take is that increased fund flow volatility does indeed represent a tug of war between the bulls and the bears. This indecision can often occur prior to a change of trend.
My view is that the NASDAQ is a massive bubble. The only question is whether it pops soon, or continues to inflate and bursts sometime in 2021.
The good news for Aussie investors is that such an outcome should have limited impact on local stocks. Our tech sector is quite small and not economically significant.
But it does remind you that, moving forward, you can’t rely on passive investing and just shove your money in an index fund and hope it goes up, especially when it comes to international exposure.
We’re moving into the era of the ‘stock picker’. That is, outperformance will come from backing individual stocks, not punting on a sector or index via ETFs.
This is a point that my Money Morning colleague Ryan Clarkson-Leward has been talking about recently. You can read his ‘Return of the Stock Picker’ report here.
Editor, The Rum Rebellion