I took my family to the Keys last summer. In Key West, there's this cool Mel Fisher museum. Mel was born in Indiana and as a kid developed a bug for treasure hunting. After being a chicken farmer, he went off the deep end and devoted his life to finding shipwrecks. He got investors and tried for literally decades to find wrecked ships off the coast of Florida. He endured decades of struggle and failures. He even lost his son and daughter-in-law in a treasure hunting boating accident. He kept going through with the daily mantra: Today's the day!
Finally, on July 20, 1985, it was the day. He and his team found the Spanish galleon Nuestra Señora de Atocha. The mother lode yielded an estimated $450 million of treasure. It included 40 tons of gold and silver – there were some 114,000 of the Spanish silver coins known as "pieces of eight," gold coins, Colombian emeralds, gold and silver artifacts, and 1,000 silver ingots. The state of Florida wanted 25%, and after eight years of litigation, the U.S. Supreme Court ruled in favor of Fisher. He could keep it all.
The ingots (or bars of gold), silver, and copper served an additional purpose for old galleons. They acted as ballast. These days, ballast is often seawater – far less valuable. But the concept of ballast is particularly interesting right now. Ballast acts as weight to secure the boat against lateral movements. If a big wind came along and there were nothing to weigh down the boat, it would tip over quite easily. Add tons of treasure, and your boat can stand firm in the face of winds and waves – well most of them anyway.
My decades as a student of the market have led me to realize that the stock market is a bit like a boat. It has a path to follow and an ultimate destination. One hundred years of stock prices suggest that destination is "up." But to get there, it endures countless setbacks, changes in course, and faces all sorts of resistance. The market itself needs ballast. It needs insulation from volatility.
I have come to find that such insulation actually exists in the form of big money: big time money managers including pension funds, hedge funds, sovereign wealth funds, and so on. These huge amounts of money when deployed into the markets act as a base or ballast. When markets are trending and there is conviction about the future investment opportunity, markets are less volatile. When storms hit, the boat doesn't rock easily.
But when there is uncertainty like now, the big money players take risk off the table. They do this because they have great responsibility. Imagine you were managing billions of dollars. If you didn't feel confident about the investing environment, you would take risk down and wait it out. When that happens, shenanigans begin.
The Big Money Index measures the net buying and selling of large investors in stocks over a 25-day moving average. When it rises it means there's more buying, and when it sinks it means more selling. Selling is a clear sign of risk reduction by big money managers and investors. We can see here that big money has been in a downtrend since June.
This is consistent with our analysis of election years. We might want strongly for a candidate to win on Nov. 3, but no one really has any way of knowing what the outcome will be until it's over. So, consistent with all presidential elections since 1992, we have seen big money sell ahead of elections and buy afterwards. I expect the same now, and it's playing out that way.
With that said, when the big money reduces investment in the market, it's like someone removing the ballast from the boat. Suddenly slight breezes can shake the boat violently, when before if there was weight in the hull, you wouldn't even notice it.
This is what I think is happening now. When the large volumes of big money bidding for stocks goes away, spreads on stock bids and offers get wider. And typically, there's less volume on each. When this happens, high-frequency and algorithmic traders can come into the market by testing liquidity. If they sell and there's big money there to buy, their sell orders get gobbled up instantly. The algos likely cover the short and reverse to buy stocks.
But if they sell short and must sell lower to hit weak small bids, then the algos "know" they can keep selling and pushing down prices drastically. Volatility spikes, and prices sag. This can intensify the less big money there is in the market. The stoic buyers of stocks are just not there, so things can get ugly quickly: like a flimsy boat with no ballast in a sudden squall.
We saw this clearly last week. Wednesday's selloff had a high correlation – near 1 – meaning everything went down. Not just some sectors going down when others go up. Utilities was the only sector that seemed to hold its head above water. Selling was deep in energy, real estate, communications, and industrials.
When the big money is out of the market, it can get rocky quickly. This, along with earnings season, is why we expected increased volatility. It's here and rampant.
I believe that, once the election outcome is known and the country has a clearer picture of its direction the next four years, volatility should ultimately die down. I anticipate there will be a COVID-19 vaccine announced within weeks after the election. Slowly but surely, the big picture uncertainty will move on, making way for more trivial uncertainties, like whether or a not a certain company will miss estimates by a few percentage points or what the Kardashians have to say.
But now it's choppy. There was a medieval Latin phrase, dum felis dormit, mus gaudet et exsi litantro. A literal translation is: when the cat sleeps, the mouse leaves its hole, rejoicing. Or to us, "when the cat's away, the mice will play." The cat will come back soon.
The Bottom Line
We (MAPsignals) are bullish on high-quality U.S. equities in the long term, and we see market pullbacks as areas to pick up great companies.
Disclosure: The author holds no positions in any securities mentioned at the time of publication.