March 17, 2020

•  Futures go wild overnight- UP 1100 and then Down 500
• REGN announces a possible breakthrough on the virus – Futures turn UP
• Europe remains the epicenter
• Lessons on ETFs and mathematical model algos
• Try the Grilled Rib-Eye w/Gorgonzola Cream Sauce

KENNY POLCARI, Editor, Chief Market Strategist, and Consultant

Level 1 – S&P must fall 7% – 189.77 ptsCircuit breaker limits today

Level 2 – S&P must fall 13% – 352.43 pts

Level 3 – S&P must fall 20% –542.20 pts.

Stocks get hammered – falling almost twice the amount of our European counterparts. The Dow losing 3000 pts or 13%! The S&P off 324 pts or 11.98%, the Nasdaq fell 970 pts or 12.32% and the Russell gave up 174 pts or 14.13%! These indexes all closed ON THE LOWS, as the selling intensified into the final hour and that typically does not bode well for tomorrow. So get ready. The Dow has now broken the December 2018 low of 21,712 ending the day at 20,188 or 7% below that level, the Russell is a stunning 18% below its December 2018 low of 1268. The S&P and Nasdaq have yet to breach their lows of December 2018, 2347 and 6190 respectively. And while I thought those lows would hold – I am no longer confident that they will. The selling has become irrational – completely irrational that is only exacerbated by the selling of passive investments – think ETFs coupled with algos. So let’s discuss.

Now let’s just put this on the table – because I have always said the next crisis in the markets are going to be rooted in the ETF industry. An ETF is a basket of securities that you can buy or sell through a brokerage firm on a stock exchange. ETFs are offered on virtually every conceivable asset class from traditional investments to so-called alternative assets like commodities or currencies. In addition, innovative ETF structures allow investors to short markets, to gain leverage, and to avoid short-term capital gains taxes. There are many types of ETFs – below is just a sample – but you’ll get the picture.

Market ETFs, Foreign market ETFs, Bond ETFs, Sector and industry ETFs, Commodity ETFs, Style ETFs, Inverse ETFs, actively managed ETFs, Alternative investment ETFs, and so on.

And the key one for today:

Leveraged ETF: is an ETF that uses financial derivatives (options) and debt to amplify the returns of an underlying index. While a traditional ETF typically tracks the securities in its underlying index on a one-to-one basis, a leveraged ETF may aim for 2X or 3X the performance, per Investopedia. These ETF’s are available for almost anything you can imagine.

So here is what you need to understand – ETFs are like Mutual Funds, except they trade like stocks. Unlike a mutual fund –where the fund manager can SELL one name within their fund if the story for that stock suddenly changes, without disrupting the entire fund. ETFs, on the other hand, are NOT able to do that on a daily basis the way a mutual fund might do. They do though go through quarterly, semiannually or annual rebalances, but that is different than trading the individual names. If you don’t want some of the names in the ETF then don’t buy it. But, the industry has done a great job of convincing you that you do. And so – when the going gets tough (as we are now seeing) the ETF does nothing but serve to create panic across the market leaving chaos and destruction in its wake. And so you say – “I don’t own any ETFs I only own stocks.” Great! But the issue is we are all in the SAME sandbox – so when the chaos begins – the sand gets thrown in all of our faces!

So for example – the XLF – Financial sector ETF has 67 names in it and lost 13% of its value yesterday.  The top 10 names that makeup 60% of the ETF include – BRK/B, JPM, BAC, WFC, C, AXP, CME, SPGI, GS, and CB. BUT it also includes names like TFG, ICE, PNC, AFL, AIG, TROW (and 51 others) – which might all be nice US companies, but they wouldn’t necessarily be names that you would own outright. So why then own them via an ETF? Because you have to. So when the ETF gets sold (or bought) – every member of the ETF gets sold (or bought) according to its percentage participation – which under non-stressed situations is usually not an issue. But this is where it falls apart, this is where it ALWAYS falls apart.

Enter the algorithm – mathematical models that make up the majority of trading today. These models rely on a series of inputs, technical indicators, support and resistance lines, and the market’s own volatility. So when things get stressed, the algos go into overdrive only accentuating the move (either up or down). They are non-emotional and they can create havoc during stressful times. This is one of those times. What is funny is that one day they say RISK OFF and sell everything and the next they say RISK ON and buy it all back. It’s ludicrous really. That is not money management that is Las Vegas-style investing.

Because this is not one of those “non-stressed” times and this is where we have seen so many of these mathematical, algorithmically driven complex, leveraged strategies come apart at the seams. Recall the ’87 crash (algorithmically driven – Portfolio Insurance), recall the Dot Com bubble and burst, recall the flash crash of 2011 and recall the Great Financial Crisis (which was a banking issue that enveloped the globe but was exacerbated by algorithmic trading). Think of the hissy fit in the fall of 2018 – when the market lost 20% of its value. All very dramatic moves driven by algorithms. Now of the flip side – what do you think happened on the way up?

Remember all of those “great days.” Remember how there was never going to be another down day on Wall St.? Yup – the same thing – the move up also driven by mindless, mathematically driven algorithms. Most recently, think of 2019 – when we saw the market return 34+% much of that coming in the final quarter as investors (supposedly) couldn’t get enough. Or was it the algorithms that created THAT bubble as well? (Now come on, remember how even seasoned street analysts struggled to explain the ongoing rise in prices – prices that got well ahead of the economics). Now the algo guys will most likely dispute this whole conversation – of course they will – they need to talk their own book, they need to talk their own algo. They need to blame someone else and deflect the conversation away from the chaos that the technology has created. Period. But it is what it is – this is the new market.

Overnight futures markets remained psychotic. This morning REGN announces that they are supposedly close to beginning clinical trials on a vaccine.

So overnight we saw futures soar by 1100 pts only to give it all back by 5 am, and go negative (300 pts), and then closer to 7 am – they did an about-face and rallied 700 pts to go positive +400. News that REGENERON has identified the antibodies that could neutralize the virus are behind the move higher. Trials to begin by June (hopefully) and if successful – a rollout by the fall.

Now also understand that the move lower has been dramatic and broken every technical indicator out there. Macro-economic data means nothing, as the world is caught up in the virus so ANY bit of positive news concerning the virus will cause the algos to go into overdrive on the upside. Which is interesting because yesterday, for example, they crushed the market and today suddenly they love the market. Really? Only 24 hours ago the algos were telling you to unload everything. Today – they are telling you to BUY everything. Do you see the insanity in all of this? Which is why as a long term investor you stick to the plan. Stay focused and eliminate the noise. Call me to discuss.

Take good care.

Kenneth Polcari

Chief Market Strategist, Consultant

kpolcari@slatestone.com

Grilled Rib-Eye with Gorgonzola Cheese Sauce

I offer up his Gorgonzola Cheese sauce to use on a grilled rib eye or even on grilled chicken.

Preheat the grill – Season the rib eyes – set aside.

For this you need – Dry Vermouth, cream cheese, Gorgonzola Cheese, a “bouquet of thyme & rosemary” and black pepper corns (crushed).

Begin by putting enough vermouth in a small pot and bring to a boil – add in the bouquet of thyme and rosemary and allow it to reduce by half.

Now turn heat down to med – remove the bouquet and add in 1 tbsp. of cream cheese and whisk until smooth. When ready – add in an equal amount of crumbled gorgonzola and mix well – remove from heat and allow the gorgonzola to melt slowly.

Throw the steaks on the grill and cook to perfection (or as you like). When ready – remove the steaks, Slice generously and place on a warmed plate. Drizzle some of the Gorgonzola sauce on top and have plenty more in a bowl on the table. Serve with a large mixed green salad with a balsamic dressing.

**This is also great on a sliced steak sandwich with caramelized onions, fresh mozzarella on a fresh baguette. Mmmmmm…

Buon Appetito.