Why fear of missing out fuels investors
Absence of risk has created false sense of security
For the most part, the past few years have been one of the most complacent periods in history for i nvestors. While Canada has lagged behind due to its strong energy weighting, most other equity markets and especially the U. S. are benefiting from a very confident investor base eager to buy up any dips and market sell offs.
This isn’t a good thing as corrections are like mini forest fires which create a healthy and vibrant forest. The longer a forest goes without a fire, the greater the likelihood the next one becomes larger, more damaging and tougher to contain.
In today’s environment, the absence of risk or at least the perception of it, has provided investors with a false sense of security while the fear- of- missing- out ( FOMO) has herded many into very specific segments of the market. And they are doing so in a big way.
Consequently, we’re now seeing huge speculative long positions in crude oil, the euro and the S& P 500 while at the same time large short positions in U. S. Treasuries and the U. S. dollar. Outside of the futures market, regular investors as well as institutions have jumped in with both feet, borrowing a record US$ 642.8 billion in margin accounts to buy even more securities, according to the Financial Industry Regulation Authority and as cited in the Wall Street Journal. More recently, we’re seeing a lot of these purchases crowd into the FANG ( Facebook, Apple, Netflix and Alphabet) stocks resulting in a handful of technology stocks that have been driving the majority of the recovery in the S& P 500 over the past few weeks.
However, the problem is the chaos created when these trades unwind.
Take for example what set off the latest sell- off in the market. For some time now investors were shorting something called volatility ( VIX) one- month out in the futures market or margining their portfolios and buying inverse VIX Short-Term Futures ETFs.
This trade worked as long as the forward curve remained in contango, meaning forward prices are higher than the spot price, as it allowed investors to capture the yield from the fall upon contract expiry down to the spot price.
Since volatility kept on compressing and U. S. markets went for such a long period of time without a downturn, thanks to investors who kept on buying the dip, this became viewed as an “easy money” trade and a great way to add some yield to one’s long portfolio. Then suddenly out of nowhere the VIX spiked and because the short trade was so large it caused a covering and investors had to put up cash and/or sell their long positions which in turn put tremendous pressure on the market.
You would t hink t hey would have learned their lesson, but with the recent stabilization in equity markets many are back at it once again i mplementing this trade.
A similar situation appears to be unfolding in the oil market thanks in part to its forward curve being in backwardation, meaning forward prices are lower than the current spot price. As a result, investors are going long one-month out and capturing the gain when it rolls up to the spot price at expiry.
This trade is so large that speculators now own more than a billion barrels of oil for the first time ever.
Overall, it’s important to remember that there is no such thing as a free lunch so beware whenever you hear of an “easy-money” trade. Instead, take the time to know what you own which means trying to measure the risk involved against the potential reward being offered. And remember, just because there are many others in the same position doesn’t means it’s less risky, but perhaps the opposite.
REMEMBER THAT THERE IS NO SUCH THING AS A FREE LUNCH.