Algos And ETFs Might Give Stock Pickers A New Life

That was just an example, and, obviously, several other causes might have contributed to this outcome. But looking carefully, you can find a myriad of similar examples throughout the market.  In itself that is nothing new, the market is full of stories of overdone movements, be it panics or euphorias.  However, my argument is that algos are making them more frequent and rapid. Wrapping-up, stock pickers should have a better chance of spotting these exaggerated moves and trade them.

ETFs are changing the market rhythm

Another interesting development is the fact that ETFs tend to lift entire sectors very rapidly.  And, then, they also tend to drop at the same speed. Basically, they are causing boom-and-bust sequences, at a faster pace than was the norm. Because those are also self-reinforcing movements, sometimes, we end up with industries with better fundamentals than the pre-boom period. However, when a soft landing comes, the money vaporizes from the ETF, and we end with companies at pre-boom price levels, but better fundamentals.

The ETF’s mechanics are very interesting. Since ETFs trade like stocks, they tend to replicate the stocks in their portfolio. However, there is a huge degree of reflexivity underneath.  If a sector, represented by an ETF, falls out of favor, it will be sold by investors.  A negative flow, coming out of an ETF, will weigh negatively in every stock present in the ETF. A good example is what happened to financial ETFs after the Presidential election. According to analysts from Keefe, Bruyette & Woods, $9 billion flowed into financial ETFs. On average, shares of stocks in ETFs rose more than shares of companies that weren’t. That speaks volumes about the inefficiencies that ETFs are provoking.

Graph 2 – Funds flowing to ETFs

(Click on image to enlarge)


(Source: Financial Times)

One good illustration of the ETF effect is the semiconductor sector. From June 2016 until June 2018, Micron in particular, and the semiconductors, in general, rode the Trump trade magnificently.

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