Technically Speaking: A Shot Across The Bow For “Passive Indexers”

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via EmailFacebook or Twitter.

I wanted to pick up on a discussion I started in this past weekend’s missive, with respect to both Friday’s rout in technology stocks as well as Monday’s rather nasty open. While the issue seemed to be a simple short-term rotation in the markets from large capitalization Technology and Discretionary stocks into the lagging small and mid-capitalization stocks, the sharpness of the “Tech Break” on Friday revealed an issue worth re-addressing. To wit:

Both Discretionary and Technology plunged on Friday as a headline from Goldman Sachs questioning ‘tech valuations’ sent algo’s running wild. The plunge was extremely sharp but fortunately regained composure and shares rebounded. A ‘flash crash.’

One day, we will not be so lucky. But the point I want to highlight here is this is an example of the ‘price vacuum’ that can occur when computers lose control. I can not stress this enough. 

This is THE REASON why the next major crash will be worse than the last.”

I am not alone in this reasoning. Just recently John Dizard wrote for the Financial Times:

“The most serious risks arising from ETFs are the macro consequences of too much capital being committed in too few places at the same time. The vehicles for over-concentration change over time, such as the ‘Nifty Fifty’ stocks back in 1973, Mexican and Argentine bonds a few years after that, internet shares in 1999, and commercial property every other decade, but the outcome is the same. Investors’ cash goes to money heaven, and there is a pro-cyclical decline in productive investment.

Risk concentration always seems rational at the beginning, and the initial successes of the trends it creates can be self-reinforcing. Since US growth stocks such as Avon, the cosmetics company, Polaroid, the photography group, and IBM, the computer company, outperformed the market, growth-orientated portfolio managers raised more money in the early 1970s, which then led to more cash going to buy the same stocks.”

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Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Streettalk Advisors, LLC expressly disclaims all liability in ...

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