Stocks continue to soar...
Since its lows in late March, the S&P 500 has gained roughly 40%. It's now darn close to hitting new all-time highs.
You might not realize it, but much of this move has been powered by "machine buying." Specifically, hedge-fund quant and algorithm programs continue to drive market gains.
The good news is, these models continue to work in our favor. So we should expect the recent surge in stocks to continue.
Let me explain...
The market has a secret driver – and few investors even realize it exists. It's the computer-driven buys and sells that come from sophisticated money managers.
Some estimates place industry assets at $1 trillion. One area that I like to focus on is commodity trading advisors ("CTAs"). Wall Street brokerages estimate that this part of the industry has about $250 billion in assets.
But those assets can be anywhere from two times to 10 times levered... So $250 billion in assets can have market impact of anywhere from $500 billion to $2.5 trillion.
These quant and algorithmic hedge-fund models operate much differently than those of their competitors. Typically, their investing style is driven by the market hitting key trigger levels on the way up and down.
Let's look at the S&P 500 Index. When the market is rising, it will typically hit key levels – like the 50-, 100-, or 200-day moving averages ("DMAs"). These are simply momentum measures that smooth out volatility to show the short-, medium- and long-term trend.
The chart below shows these levels...
When an index breaks above one of those moving averages, it's usually a trigger level for these machine programs. The models tell them to buy more stock. And they don't just buy – they buy without trying to get a specific price. They keep buying until their order is complete.
Conversely, when an index closes below one of those moving averages, it tells the models to sell stock. And, much like the buy indicators, they don't have price limits on their orders.
There's more, though... Because they're hedge funds, they have the ability to go short on stocks. So if they're done selling out of long positions, and their models are still saying "sell," they'll end up shorting different markets.
These algorithmic models were designed to take advantage of gradual moves upward or downward in the markets. They're not built for markets experiencing wild swings.
So in times like these, the tremendous amount of buying and selling can intensify the market's moves.
As the industry has grown, we've seen increasing amounts of money flow into the same trades. There's a limit to the ideas out there, and "proprietary" ideas never stay that way for long. And when all those assets are overly long or overly short, it inevitably leads to a huge unwind in the other direction.
With stocks soaring today, more and more funds are moving from shorting the market to going long. And in some cases, it's a full reversal.
So as the market moves up with a new round of buying, it's likely to trigger more programs to do the same... creating a feedback loop.
That virtuous cycle is in place for the market now. And as surprising as it might seem, that means stocks are a smart bet today.
C. Scott Garliss
Editor's note: Recently, Scott shared a surprising sign of real economic recovery in the U.S... what to expect next from the Federal Reserve's crisis-management plan... and much more. It's all part of his real-time financial news service, Stansberry NewsWire. For expert commentary, market snapshots, and daily alerts on the most important stories for you and your money – like these – sign up for free right here.
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