Nick’s Note: Yesterday, I had lunch with PBRG’s Wall Street insider Jason Bodner, editor of Palm Beach Trader. Regular readers know that he has nearly two decades of experience working at large Wall Street firms like Cantor Fitzgerald, where he was head of equity derivatives for North America.

Jason created a proprietary system that scans nearly 5,500 stocks every day to find the best of the best. He also has a unique insider’s perspective… So I wanted to get his opinion on the market’s recent volatility and what to do about it…

By Nick Rokke, analyst, The Palm Beach Daily

Nick: Jason, why has the market tumbled lately?

Jason: The short answer is that we’re seeing a lot of forced selling. Let me explain what I mean…

On Wall Street, a lot of firms use systematic trading systems, or algorithms. These systems control the buying and selling of stocks.

Now, when stocks go up, it’s great. The systems say to keep buying, so that’s what portfolio managers do. And that helps the market steadily rise over time.

But eventually, the market stalls or falls. There’s going to be a hiccup somewhere.

Anything can cause it. And in October, we had a perfect storm of uncertainty around the midterm elections, trade war fears, rising interest rates, and other events.

This uncertainty made some investors nervous, and they stopped buying. This lack of buying set up the market for a fall. And once the market goes down a certain level—3%, 5%, or whatever—these systems eventually flash sell signals.

When that happens, it exacerbates the sell-off.

Wealth managers will start selling exchange-traded funds [ETFs] to reduce exposure for their clients. And when large wealth managers decide to do this, they’re not just selling a couple hundred shares of an ETF…

They’re selling millions of shares.

Nick: Can you give us an example?

Jason: Let’s say a manager wants to sell $250 million worth of ETF shares.

He can’t just go on the open market and dump that many shares. That would cause a mini flash-crash.

Instead, he’d call up a guy like me.

When I worked on the derivatives desk at Cantor Fitzgerald, we’d get calls to sell a large chunk of an ETF.

But we weren’t about to take on that market risk. So we’d buy the ETF from our client… and right away, we’d go and sell short the shares of the underlying companies in that ETF.

That could push the market down.

Then, there’s the hedge fund managers. They’d see their funds decline 10% in a month, and you’d think the world was about to end. It’s a cataclysmic event for them.

In cases like that, they’d “flatten” their books—meaning, they’d sell just about everything and start over.

Nick: So how long will this selling go on?

Jason: The Wall Street answer is: “It’ll go on until it’s over.” No one can be exactly sure how long it’ll take.

During the market correction at the beginning of the year, it took about two months for the selling to stop. Remember, the Dow plunged 1,175 points on February 5—the largest intraday drop in history—during that correction.

Now, we’re nearly two months into the current sell-off this time around. But it looks like selling is finally drying up.

It might not seem that way… Last week, the market cratered 4.2%, but that was a short week due to the Thanksgiving holiday. Most of the big traders were on vacation. So this move happened on very low volume.

I wasn’t surprised at all to see the market bounce on Monday and then continue higher on Tuesday. Low-volume moves are always suspect. They usually reverse.

And Wednesday saw the market skyrocket on dovish comments from the Federal Reserve chair on interest rates.

My system showed a good amount of institutional buying coming in on those days. The amount of stocks making it through my initial filter for unusual volume and volatility was at normal levels.

That means the unusual buying had volume behind it.

Nick: That’s great news. I’d love to see my portfolio go higher again… So what sectors do you think will catch a bid first?

Jason: Right now, we’re seeing strength in big dividend-paying companies. These are commonly referred to as defensive stocks.

We’ve seen a lot of strength in consumer staples, utilities, and real estate. And I expect we’ll continue to see strength there as the market chops around a little.

There’s a reason behind that…

You see, there’s a lot of money invested in “long-only” funds. These funds need to invest in stocks. It’s written in their mandates.

These managers can’t just sell their investments and wait in cash for a month or two. They need to be in the market. So they sell their speculative investments and big winners and move their money into defensive sectors.

I think the next sector to thrive as investors rotate between sectors is healthcare. Investors consider it to be defensive as well.

People will see the doctor no matter what the economy is doing. And these companies are also expanding and growing quickly.

My system has seen a lot of unusual institutional activity in healthcare. So the big-money guys are quietly moving their cash there and waiting for the next move up.

Nick: And how can our readers take advantage of this trend?

Jason: The easiest way to get healthcare exposure is to buy the Health Care Select Sector SPDR Fund [XLV].

Nick: Great. Thanks for taking the time to talk to me today, Jason. Have a good one.

Jason: You’re welcome.

MAILBAG

Readers respond to our recent interview with Teeka Tiwari about the temporary pullback in the crypto market…

From Charles D.: Thank God I followed your advice and only invested what I could afford to lose in cryptocurrencies.

I started out a year ago just learning about bitcoin. I was one of the lucky ones who invested and hit it big when bitcoin went over $19,000. I sold quickly and made a nice profit. I reinvested about $3,500 of the $11,500 I made, and really started to dig in and learn about this new asset class.

Today, you’d think anybody would be nuts to get involved in cryptos. But I’m in for the long haul because I believe in this asset class. I’m letting the game come to me.

From William S.: Teeka, thanks for the update. I trust you more than anyone else in the crypto space. I’m holding firm, but it ain’t easy. Please continue to give us regular updates.

From Hamlet R.: I’m trusting Big T. I’m down 50%, but I’m still buying more crypto. This asset class will turn around.

And another reader appreciates guest writer and PBRG friend David Forest’s insights on copper mining…

From Preetham N.: David, that was an interesting piece on the strategic race for copper. Thanks for shedding light on the upcoming copper demand. I’m a mining engineer and an active trader in the stock market. Hence, I follow mining stocks very closely.

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