• How to trade an index following environment?

    Index following looks very powerful: it is a big tidal wave of money that pushes everything up.
    This hypothesis is based on the narrative that because of the Fed's planned rate hikes, money rotates from US Treasuries into US equities. The second narrative is linked to ETF buying by foreign entities (BOJ) and foreign individual investors fleeing the Euro and the Yuan.

    If we look only at last Friday, we can see that the final 40 minutes of trading mostly profited the S&P500.



    Most of the XLX ETFs (large caps) also moved higher. This can be seen on XLE.



    NQ100 also attracted money starting at 15:20.



    Even IBB attracted much money. This is because the 10 largest stocks in IBB make up 57% of the index.



    GDX however did not attract end of day money, because the great majority of gold mining stocks are not part of the largest ETFs.



    These end of day moves looked strange in a day that was dominated by Treasury buying and carry trade unwind (Yen pushing higher.)




    On a longer-term picture, we can see that the Mammoth stocks have attracted much more money that the S&P500 stocks.



    Even within the S&P500, the 250 biggest stocks have attracted more money than the 250 smallest.



    On the other hand, the small caps look much weaker in terms of money flow.



    Even Jerry's set of leading stocks (which are often small caps) was underperforming on Friday.

    http://www.effectivevolume.com/showt...-Index-2-24-17

    On a much longer term picture, I have recalculated the one year Active Boundaries linked to the Price volume daily exchanges on the S&P500. This figure represents the one-year profit at any time in the past years (starting with the crash of 1987.)

    We can see that profits gained much just the year following a big market crash. We had three such moves. Most recently, we can see that the yearly profits have usually topped at around 15%. In our case, that would put the S&P500 target at $2465. That is where I believe this wave of index buying could take us in the coming weeks.



    I would again like to point below to the IWM/SPY ratio, which shows that IWM is underperforming SPY.



    Is this relevant? In the context of index buying, then this points to investors shorting small caps to hedge long positions in the largest companies.

    What I found interesting though is to find IWM moving higher while still underperforming SPY. This is very unusual. We can indeed see below that whenever IWM was in an uptrend, it was also outperforming SPY... except at the end of 2016, just before IWM collapsed. I do not say that this will again be the case soon for IWM, but this is certainly something to take note.



    Conclusions:

    What are the coming events that could make the music stop?

    1. A Fed rate hike in March would be more negative for small caps than for larger caps, which will profit from a rotation out of Treasuries into equities.
    2. The most probable event will be the unwinding of Euro short positions when it will be clear that France will not elect an extremist President. This could happen much faster than anyone expects. Investors are looking at the surprise Brexit and Trump votes, but the French vote is very different. It is similar to the Greek vote to stay in the Euro zone: French voters know that their social security was funded through very low rate borrowings that were only possible thanks to the Euro.