So Exchange Traded Index funds and the $1.2 trillion invested in them have increased volatility for small cap stocks making the whole IPO process less attractive for many founders of U. S. tech companies — our kind of companies. It’s not the end of the world but has been a downer of sorts for both the market and the tech industry for the last decade. What’s to be done about it, then?
“The problem as we see it could be 80-90 percent contained if only Exchange Traded Funds were subject to the same sort of trading circuit breakers that were imposed by the SEC on regular shares after the Flash Crash of earlier this year,” says Bob Litan from the Kauffman Foundation.
The fact that such circuit breakers haven’t already been imposed, stopping trading altogether when things get a little too crazy, makes no sense at all, at least not to me. What’s good for the stock is good for the index that trades like a stock. So do it.
The better question, though, is how do we actually benefit from this situation? How do we — smart nerdy we — make a few bucks on these ETFs that aren’t going away?
I have a plan.
Here’s where it might be a good idea to go back to my last column and read or re-read it so I don’t have to write that stuff all over again. Notice the comments, too, since those folks are far smarter than I am.
So we have this market that goes up and down based on, well, something (nobody is quite sure what) but smart traders can make a good living from it, so why can’t we? I think we can. I think we can make an extraordinarily good living from it simply because much of the Index ETF volatility has nothing at all to do with the individual stocks contained within the index. The price goes up or down for whatever reason and the ETF’s — huge institutional investors in their own rights — are required to rebalance their portfolios to reflect the new market values — values that are, for the most part, artificial.
As a result, shares of the Acme Transistor Company go up or down when it makes no sense for them to do so if you know much about the Acme Transistor Company. Because the bozos running the ETF that is the largest shareholder in the Acme Transistor Company by definition know nothing about what happens there. They simply don’t see it as their business — a very un-Buffettlike way to invest.
Warren Buffett, now that his name has been dropped, wouldn’t pay any attention to this because, as a value investor, he completely ignores this kind of volatility. And as a huge investor, he actually ignores these entire companies because there simply isn’t any way he can stuff enough of his money into any of them to satisfy Berkshire Hathaway’s hunger for shares.
If you are buy-and-hold, then by all means buy-and-hold. But if you want to try and play the game a bit, here’s what you need to remember: for intrinsically good companies this is a zero sum game. Prices that dramatically dip will eventually rise again. And those that dramatically rise will eventually dip again, absent any real news.
Become a specialist in a few little companies within an index like the Russell 2000. Follow both the rumors and the news. If the stock swings wildly and there is no news, no rumors, no insider head feints, no reason at all for that to be happening other than that when elephants fight the grass is trampled, well that’s actionable. Buy or sell as needed, maybe (definitely!) get some leverage by trading options. Short the stock if it is going up or go long if it is going down.
What we have here are two different trading universes and each is simply noise to the other. When you have a sense of the rhythm of an individual stock you can trade on the ETF noise. Rhythm and noise — it’s an inter-dimensional trading algorithm that actually works.