• Passive strategies, weekly comments for October 30, 2016

    I was about to increase my short positions last Friday when US election-related issues hit the tape. I believe this move is a head fake and that this week will usher in a bounce from oversold levels. My goal is to increase put buying in small caps during the coming bounce.

    With short term comments "out of the way," let's look at how passive investment strategies have performed in past weeks.

    1. Nirp Refugees

    The most recent passive strategy was the influx of NIRP refugee money in large caps and dividend-bearing instruments.

    One of these was the buying activity in VNQ, which is the largest REIT ETF.

    We can see that VNQ started to attract money in February, when the BOJ went full NIRP, but fell back at the end of July.



    Priced in Yen, VNQ is barely above its February level.



    Let's now analyze the TEV (Total Effective Volume) pattern for VNQ. As a reminder, Effective Volume measures the buying/selling balance every trading minute. If the price increases during a trading minute, the volume balance is deemed to be from buyers. Effective Volume is hence only a measure of buying versus selling forces. Because markets are in a stable liquidity-based equilibrium, Effective Volume tends to point to investors' intentions or hope for that specific instrument.

    Through the end of July, VNQ's TEV pattern was very positive, each price dip being bought.



    Then, we can see that it took some time for the TEV pattern to change to a sell mode. Sellers came in force only at the end of September, which is well after the price broke down. The TEV pattern is now in full sell mode. This indicates that passive investors have finally given up.

    This selling naturally puts pressure on all individual REITs, but it offers two interpretations:

    1. Passive investors who are giving up will not come back soon. They have been burned and will want to stay out. They are followers. Not leaders.
    2. Extreme selling by passive investors might be an indication that it is time to buy.



    This may be what the Money Flow calculated on individual REITs is telling us: this MF is reversing back to the 0 line, indicating that large investors are reluctant sellers.



    Among these, VTR, PSA and AVB have published "inline" earnings last week and have been attracting good money.

    VNO, KIM and FRT have also been attracting good money, but will publish their earnings this week. I do not believe these REITs will collapse.

    However, the future price of dividend-bearing investments depends on interest rate perceptions. For now, the market expects the Fed to increase rates in December. This will probably be the time to buy REITs... unless the Fed also increases rates on Excess Reserves.

    2. The oil market

    The oil market is also interesting to analyze.
    We can see below that oil futures are under selling pressure.



    USO, the largest oil ETF, is however still being bought in very large quantities. Since August, buyers have been exceeding sellers by 140,000,000 Shares times $10 = 1.4B$. This is not a small amount.



    It is strange to see such a move since USO has underperformed WTIC by about 50% in the past two years. The best way to take advantage of this strong buying is to take USO short positions when USO spikes 4% to 5% above its 5MA.





    We can see that DBC, which is only 50% oil related, has also been attracting money.



    HYG and JNK, the two junk bonds ETFs, are under selling pressure due primarily to higher interest rates, but weaker oil prices could trigger another selling wave.



    3. ETFs that track Indexes

    The most popular trackers are SPY, QQQ and IWM. Let's compare the TEV of these ETFs with the Money Flow of the underlying stocks.

    The SPY TEV is almost non-directional, while the S&P500 Money Flow has now moved back to the neutral zero level. This does not indicate a market on the verge of collapse.





    The QQQ TEV is very negative, while the NQ100 Money Flow is also back to neutral.





    The IWM TEV is rather negative, together with the Non-SP500 Money Flow.





    The TEV of these popular ETFs shows neither unusual accumulation nor distribution activities.

    The above figures clearly show that small caps are underperforming the S&P500, which is also underperforming the NQ100. The selling in the QQQ might be due to the huge size of AAPL compared with other stocks: more QQQ units had to be sold than usual in order to cope with AAPL's latest earnings miss.

    The general idea of the above figures is that it makes sense to short small caps (IWM) in strength.
    In the figure below, I compare the IWM pattern to the IWM/SPY pattern. In yellow I highlighted the last two occurrences when the underperformance of small caps turned into overperformance. These events occurred after a strong wave of selling. The present pattern looks somewhat different: the IWM/SPY could break below its uptrend or could bounce from here and test again the top of the uptrend.



    Conclusions:

    Everything is hanging on what the Fed does with interest rates. The whole market anticipates a rate hike in December, hence the pressure on REITs and small caps. However, the 10Y rates have already bounced. This tells us that a rate hike in December will actually not have negative consequences.