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Dominant stocks, short-termism, a trader's playground. Might as well embrace it.
The markets continue to show us just how much investing has changed over the past half decade. The pandemic had a lot to do with that, but as with many other aspects of our lives, much of what is different now is just the result of that rare time in our lives speeding up some trends already in place. Here’s what I think has changed, and how it is playing out in the markets right now:
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They move faster, and the moves are far less sustainable in length and magnitude
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The bond market is not like it was - it is more like a less skittish version of the equity market
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A small number of very large stocks continue to be the market’s focus. Ask anyone who has spent the past decade touting small cap investing or international stocks. But the longer this goes on, the more it looks more like the economy itself. See a local hardware store or travel agent recently?
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Markets are much more prone to “binary” periods, in which nearly all sectors and even stocks move in the same direction.
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“Everyone” is an investor now. That is fantastic for humanity, but it also changes the dynamics quite a bit. It creates ways for people to grow their wealth, and also opportunities for other, more tenured to take advantage of what the newer investors assume to be true, but likely isn’t.
These are not bad changes. That is, if you recognize that they are occurring, and that many of Wall Street’s traditional ways for how things should work have gone out the proverbial window.
Performance That Matters
Just look at those bookends! SPXU is the 3X short S&P 500 ETF, and UPRO is the 3X long S&P 500 ETF. And this doesn’t include today’s market activity, in which SPXU fell by 5% and UPRO, as we’d expect, gained 5%.
I am spending more and more time on leveraged ETFs. NOT because I think any investor should jump into them, or even consider them. That’s a personal decision.
However, I am finding very specific and careful uses for them in my own investment management. Or, more to the point, the trading aspect of my overall portfolio work.
The #1 thing any investor should keep in mind with these things: POSITION SIZING. If I allocate, say, 1% of a portfolio to either SPXU, UPRO, or a growing number of 1.5x, 2x and 3x ETFs that operate in one direction or another, the first think I remind myself is “that’s all I can lose, just like an option.” And as you can see in the rightmost column above, SPXU has a 97% “drawdown” on its record, and UPRO has declined 77% at one point since the pandemic started.
Drawdown is a polite Wall Street word which means how much an investment fell in price from any peak level to a trough level. Like when a company has “negative earnings.” They didn’t earn a dang thing. They lost money.
Even excluding today’s very strong day for stocks, SPXU is still ahead of UPRO since the market’s recent peak on July 16. But that difference is narrowing super-fast. That’s today’s story, but the more I go back and study what has occurred in markets that present themselves like this one is, the more I believe that this is late-cycle activity. In other words, enjoy the party, but stay close to the exit door. That approach has made this one of the better, most balanced phases of my investment career.
I have always been about risk management. But modern markets beget modern tools, and the more we learn to use them, while maintaining a balanced and humble approach, the more successful I think we’ll be.
So whether it is ETFs, levered versions of those, tactical management, options or just plain old stock selection using technical analysis and the other parts of my process, I can truly say that at our shop, we feel as prepared to exploit any market environment as at any point since I came out of college in 1986 to enter the industry I never left.
Related: What a 1,000-Point Dow Loss Tells Me