Attack of the Passive Robots

  • Here’s what will trigger “the next catastrophic stock market meltdown”
  • How “robo advisers” and “passive investing” are inviting disaster
  • Skirting the U.S. dollar…Venezuela joins the ranks
  • Is Treasury Secretary Steve Mnuchin a mooch? Does it matter?
  • Inflation on the rebound… freezing your credit (even more of a joke than we thought)…the nerve of Jamie Dimon… and more!

“There’s a giant problem brewing on Wall Street,” says our Jonas Elmerraji. “It’s going to cause the next catastrophic stock market meltdown.”

When Jonas says something like that, we perk up. We’re not used to hearing “big picture” predictions from him. Jonas is a guy who takes his cues from the price action of stocks — or, as one of our more disparaging readers calls him, a “chart chimp.”

So what’s prompted Jonas to step out of character at this time?

“It seems that suddenly, Wall Street’s computer-driven quantitative-trading strategies aren’t working very well right now,” Jonas says.

Entire hedge funds have been built around computerized strategies… and they’re having a rough year, according to a recent Bloomberg story. One of these funds has it so bad, it’s closing up shop. What looked like a can’t-lose approach is bleeding away investors’ money at a time the stock market is touching all-time highs.

The Bloomberg article was thin on explanations. Why would something that’s worked reliably for years suddenly start flying apart?

“The root cause of the problem is that there isn’t as much so-called ‘dumb money’ in the stock market anymore,” Jonas explains.

“These days, many retail investors are investing with so-called ‘robo-advisers,’ a totally different sort of computer that helps folks allocate their money more intelligently and without the help of a human financial adviser.”

There’s not a lot of sophistication to these robo-adviser systems: “They ask you questions about your age and retirement goals and then allocate your money according to the conventional wisdom based on your answers.

“If you’re older, the robo-adviser will allocate your account more toward bonds and less toward stocks. If you’re younger, you’ll get more stock exposure. You get the idea. It’s really basic stuff. But since a computer is making the choices, it’s cheaper than paying a human expert.”

All the major brokers are getting in on the act: Vanguard, Fidelity, Schwab, TD Ameritrade.

In a nutshell, here’s the problem with robo-advisers: “They all pretty much do the same thing,” Jonas says.

“And when everybody is investing in the exact same things (even if those investment allocations are generally good ones), there can be some very bad unintended consequences.” The more me-too hedge funds that adopt “quant” strategies, the more likely it is that those strategies will cease to work the way they once did.

And so all of a sudden, “quant” strategies that worked for a long time don’t work anymore.

As money manager and blogger Josh Brown put it a year ago, “Today’s arms race into quantitative and algorithmically driven strategies will be no different than all other Wall Street arms races of the past: The getting is good at first, until it works. Then it becomes a circular firing squad, as thousands of people and institutions pick each other’s profits off while engaging in similar strategies.”

Which leads to an uncomfortable question: “What happens,” says Jonas, “if we experience a sharp correction in the next year or two while a growing mountain of money is all invested in the same thing?

“As the first round of investors suck money out of robo-adviser funds to have extra cash on hand, the robots have to start selling the stuff they own to cover the redemptions

“And as that selling pressures prices to drop, it creates an echo chamber for the folks still holding on — the start of a very bad chain reaction that could send prices plummeting. Worst case, I think this robo-adviser trend could spark the next stock market meltdown.”

A meltdown made worse, we’ll add, when robo-advisers combine with “passive investing.”

A typical mutual fund of the sort in your 401(k) is managed either “actively” or “passively.” Active managers select the stocks in the fund based on their own thought and analysis. Passive managers simply follow an index like the S&P 500.

In recent years, active managers have taken a lot of flak for underperforming — and rightly so. Worse, actively managed funds usually have a higher expense ratio, cutting into your returns. So you’re paying more but getting less. Why bother with that when you get lower costs and better performance by simply following the indexes?

Passive investing is a major reason the “Big 5” stocks of 2017 have gotten so big. If you plunk $100 of your 401(k) into an S&P 500 index fund… about $3.92 will go into Apple, $2.69 into Microsoft, $2.62 into Alphabet (Google), $1.91 into Facebook and $1.82 into Amazon.

If you keep doing that every two weeks… and if millions of others like you do the same thing… you see how the biggest companies just keep getting bigger, regardless of their profitability.

But when the stock market starts turning south — you know that’s going to happen sooner or later, right? — this process will feed on itself in reverse. Selling will beget more selling.

What might have been a garden-variety “correction” in the markets might easily turn into a crash, thanks to robo-advisers and passive investing.

Even if a crash doesn’t result, it’s inevitable that robo-advisers and passive investing will stop working as well as they used to. It happens anytime a strategy becomes too popular.

What’s your best defense? That’s something Jonas has been working on for the better part of five years. It’s a computer-driven trading system, but one that’s unlike anything Wall Street has ever seen. “I designed it to look at the markets from a non-Wall Street viewpoint,” he says.

“It has a lot more in common with the computer intelligence being developed in Silicon Valley right now than it does with the quantitative platforms being used by Goldman Sachs or the various hedge funds that are feeling the burn of awful performance this year.”

We’ve told you about it before. We even gave you a couple of “free trades” back in June that have worked out well. Apple is up more than 10% in the last three months and gold is up 5%… while the S&P 500 is up only 3%.

If you played it with options, your gains would be much greater — Jonas’ readers have parlayed that gold move into 57% gains.

There’s truly nothing else like it. Learn more about how it works at this link.

The market action today is a snooze: The Dow is up a bit, the S&P down a bit. Gold has barely budged at $1,324.

If it’s action you want, it’s in crude. A barrel of West Texas Intermediate is back above $50 for the first time since early August; traders anticipate growing demand.

The August consumer price index rang in a little hotter than expected — up 0.4%. The year-over-year increase works out to 1.9%. It appears that a steep decline in the inflation rate that began in February bottomed out in June; it’s been slowly climbing the last three months.

A follow-up to our big theme in yesterday’s 5: Add Venezuela to the list of governments trying to get out from under the dollar’s thumb.

This morning’s Wall Street Journal says President Nicolás Maduro’s government is trying to do an end run around U.S. sanctions by refusing to accept payment in dollars for its plentiful oil. Traders are being urged to transact in euros instead.

Unlike China, Russia and Iran… Venezuela’s move appears largely symbolic. Most of the country’s oil exports go to the United States, and oil accounts for 95% of Venezuela’s hard-currency earnings.

That said, we’re sure Maduro’s gambit will be noticed in Washington. In late 2000, Saddam Hussein declared he wanted payment in euros for Iraq’s oil. Just over two years later, Washington carried out “regime change” in Iraq. We’re not asserting cause and effect, but the parallels are, uhhh, interesting…

OK, the travel-expense saga of Treasury Secretary Steve Mnuchin and his Hollywood bride has jumped the shark.

We were happy to have our share of fun in The 5 last month when Mnuchin ventured to Fort Knox, Kentucky, to eyeball the national gold stash… and wife Louise Linton got into an argument on Instagram over the couple’s use of a government plane.

Aaaand we had fun when news broke that the Treasury opened an internal investigation because it turns out Mnuchin and Linton made the trip on Aug. 21 — which happened to be the day of the big eclipse and Fort Knox happened to offer an ideal view.

Now ABC News reports that the investigation has expanded into Mnuchin’s request to fly on an Air Force jet for the couple’s European honeymoon earlier this summer. In the end, he withdrew the request, because it turned out he could conduct government communications securely without the help of an Air Force jet.

So now we’re supposed to care that he didn’t take a government plane for his honeymoon. Or something like that.

The Mnuchin travel imbroglio has become a faux controversy of the sort the media love to manufacture to distract us all from the real issues.

When it comes to scandals involving Mnuchin, isn’t it more important that he might have committed perjury when talking about the mortgage shenanigans at his old company? Or that he all but issued an engraved invitation to other nations to ditch the dollar as the globe’s reserve currency? But no, we can’t talk about that…

On the topic of the Equifax hack, a reader writes to tell us that freezing your credit is even less than we’d cracked it up to be.

“Due to multiple ID theft events,” he writes, “I have had a credit freeze at the three major credit agencies for several years. This impacts my ability to open a new credit card account from a major bank. However, I have found to my dismay that credit/loan accounts can indeed be opened without my having to provide a temporary ‘unfreeze’ as is believed.

“Just one of several examples: I live in New York. I was in a Florida jewelry store and had the chance to get a 10% discount on a ring I liked if I opened a store credit card. This card was no different than a Macy’s, Target, etc., store credit card. While the saleswoman was putting my application into their online system I commented to my wife that this is not worth the time, as it will not go through due to the credit freeze, and since I could not request a temp unfreeze there in the store, I was not going to get my new card or 10% discount.

“Well, the saleswoman returned with a big smile and said I was approved! I said, really, I am surprised. She then related that ‘we have a really high percentage of approved customers here.’ I thought, Oh, good grief, how wonderful is that…

“I am using monitoring services of three — count ’em, three — credit monitoring agencies. My experience with this service is similarly substandard.

“On a related note: Think I have a warm feeling about the security of cryptos? Ha.”

On the topic of JPMorgan Chase CEO Jamie Dimon’s bitcoin-as-a-fraud remarks, a reader writes:

“Actually, from personal experience, I would say Emperor Dimon is himself a fraud and a gangster. He got the CEO role with JP Morgan shortly after the ‘merger’ with Chase, and at that time I was working as a consultant for JPMorgan in Asia. He was not in the role for very long before he unilaterally cancelled consulting contracts globally.

“It was basically a matter of ‘I don’t like consultants, so all contracts are cancelled’ with an implied ‘Sue me if you have the funds.’ Simple case of ripping off the little guys. Many of the contracts that were cancelled were short term anyway — three–six months — so letting them expire and not renew would have been an acceptable pathway. But that was not to be. He had to show everyone how tough he was.

“In future, anyone wanting to do outside work for Dimon and his ilk should ask for payment 100% in advance — in bitcoin, so they can’t change the rules (including reverse payments) midstream and rip off the little guys. And NEVER use any blockchain-based digital payment systems that these I-banks have set up, because these will be set up so as to control everyone else for their own benefit.

“Cryptocurrencies, with fully distributed ledgers, are the wave of the future, and they will even the playing field big-time. The more people who get involved the better. Before the controls on the U.S. dollar and other fiat currencies (for our own benefit of course) wipe everyone out.

“I have been enjoying reading The 5 for many years — pretty much since you started, I think.”

The 5: Judging by today’s mailbag, it’s remarkable how many people who’ve been hosed by the system one way or another have such diverging opinions about crypto!

Best regards,

Dave Gonigam
The 5 Min. Forecast

P.S. We’re not sure whether cryptocurrencies have the power to take down corrupt institutions.

We do know cryptocurrencies can make you fabulous amounts of money in a short amount of time — if you know how to play them right.

One of our crypto gurus says all it could take is 35 days to rake in as much as $4 million. You can examine the evidence for yourself right here.

Dave Gonigam

Dave Gonigam

Dave Gonigam has been managing editor of The 5 Min. Forecast since September 2010. Before joining the research and writing team at Agora Financial in 2007, he worked for 20 years as an Emmy award-winning television news producer.

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