This past weekend, I was thinking about when I took my family to the Mel Fisher museum in Key West last summer.
Mel Fisher was born in Indiana and caught a bug for treasure hunting. After being a chicken farmer, he went off the deep end and devoted his life to finding shipwrecks off the coast of Florida.
He got investors and searched for decades. He endured endless struggle and failures. He even lost his son and daughter-in-law in a treasure hunting boating accident.
He kept at it, though, with his daily mantra: “Today’s the Day!”
And finally, on July 20, 1985, he and his team found the Spanish galleon Nuestra Señora de Atocha. The motherlode yielded an estimated $450 million of gold, silver, and emeralds.
Fisher (left) and his team. (Source: Melfisher.com)
The state of Florida wanted 25% of the take. But after eight years of litigation, the U.S. Supreme Court ruled in favor of Fisher. He could keep it all.
Apart from hoarding and transporting wealth, bars of gold and silver served an additional purpose for old galleons. They acted as ballast.
Ballast helps secure boats against lateral movements. If a big wind comes along and there’s nothing to weigh down the boat, it’ll tip over.
Add tons of treasure and your boat can stand firm in the face of winds and waves – most of them, anyway…
The Stock Market’s “Ballast”
My decades as a student of the market has led me to realize that the stock market is bit like a boat. It has a path to follow and an ultimate destination. (One hundred years of stock prices suggest that destination is “up.”)
But to get there, it endures countless setbacks, changes in course, and resistance. The market itself needs ballast. It needs insulations from volatility.
And that ballast exists in the form of big-time money managers including pension funds, hedge funds, sovereign wealth funds and so on.
These huge amounts of money act as the market’s base. When markets are trending and there is conviction about the future and investment opportunity, markets are less volatile. When storms hit, the boat doesn’t rock easily.
But when there’s uncertainty, like now, the big-money players take risk off the table.
This makes sense. Imagine you were managing billions of dollars. If you didn’t feel confident about the investing environment, you’d have a responsibility to lessen your risk.
When the big money reduces investment in the market, it’s like someone taking the ballast out of the boat. Suddenly, slight breezes can rock the boat… when before you wouldn’t even notice it.
For a long time, it wasn’t easy to tell when big money managers were doing this – aside from cratering stock prices. But now, we have the Big Money Buy/Sell Index (BMI)…
The BMI measures net buying and selling of large investors in stocks over a 25-day moving average. When it rises, it means there’s more buying. When it sinks, more selling.
Selling is a clear sign of risk reduction by big money managers and investors. We can see here that big money has been selling since the index peaked in June…
Barring the recent uptick in buying, this is consistent with our analysis of previous election years. In all elections from 1992, we’ve seen big money sell ahead of elections, and buy afterwards. I expect the same now, and it’s playing out that way.
And that’s naturally caused the market to respond with volatility these past few weeks…
What Happens When the Market Loses Its Ballast
When big money bidding for stocks goes away, spreads on stock bids (the price people are willing to pay) and offers (the price people want to sell for) get wider. And there’s typically less volume on each.
When this happens, high-frequency and algorithmic traders come into the market and test the liquidity. If they sell and there’s big money there to buy, their sell order gets gobbled up instantly. The algos then likely cover the short and reverse to buy stocks.
But if they sell short and must sell lower to hit small bids, then the algos “know” they can keep selling and push down prices drastically. Volatility spikes, and prices sag.
The less big money there is in the market, the worse this gets. The stoic buyers of stocks are just not there… so things can get ugly quickly – like a flimsy boat with no ballast in a sudden squall.
What Brings the Ballast Back
I believe once the election outcome is known and the country has a clearer picture of its direction for the next four years, volatility should ultimately die down.
I anticipate that within weeks after the election, there will be a COVID vaccine announced. Slowly but surely, the big-picture uncertainty will move on… making way for more trivial uncertainties, like whether or a not a certain company will miss estimates by a few percentage points. That’s the kind of market the big money isn’t nervous about buying. And that’ll be our signal to buy alongside them.
But for now, we’re in choppy waters. The market is vulnerable to big waves of selling, brought on by the slightest bit of news. So right now, the best bet is to wait out the election uncertainty and be ready to buy outlier stocks once the dust clears.
Patience and process!
Editor, Palm Beach Insider
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