Is the Reaction to Egypt Already Over?

Feb. 2.11 | About: VanEck Vectors (EGPT)

On Monday I tweeted rhetorically whether the Fed was bigger than Egypt, as U.S. equities seemed to have shrugged off whatever might be the consequence from the Egypt story. This was confirmed by an even bigger lift in the market on Tuesday. As a quick clarification: The Fed is literally bigger than Egypt, but I am talking shorter term sentiment. There are several odd things at work -- as the market appears to have moved on so quickly from this story -- that are amusing.

In general, events like the one in Egypt and whatever it may spill into come along every so often, markets overreact for a few days because "this one" is different, the market realizes it is not different, and then shrugs it off. This is often a process that takes several days -- not the one trading session, last Friday -- which makes me wonder if the market could be underestimating the significance. I still don't think this is a permanent game changer, but I do think this should be worth more than one down day.

ETF Trends had a post titled "Egypt ETFs Lure Investors in Droves." The Market Vectors Egypt ETF (NYSEARCA:EGPT) had very little volume until a few days ago, but since then the volume has gone berserk from tens of thousands of shares to either side of a million shares per day. This clearly shows that the willingness to speculate, as if we need any reassurance, is alive and well. The one-way nature of the trading for the last few months is also evidence of willing speculative behavior, which is of course what the Fed wants. The targeting of asset prices, as the Fed is doing, is an encouragement to speculate ... and this is far from a unique thought.

A blog I read on Seeking Alpha called The Housing Time Bomb refers to this as robots controlling the market, and reasonably concludes, "Why anyone would invest their life savings in something as ridiculous as today's robot controlled stock market is beyond me."

There is no reasonable denial that things are distorted by desperate policy attempting to stimulate the economy, and that one way to stimulate the economy is to target asset prices (not a belief statement on my part, just noting one of the current dynamics at work). The totality of the last 11 years (returns plus policy) will obviously cause some investors to swear off stocks forever for the reasons that The Housing Time Bomb says (and some he doesn't), but there are some important things to consider in addressing this question or maybe other questions of just how much exposure to have in stocks.

The most important thing is that we are now 11 years past what many people think of as normal stock market behavior, which is a pretty long stretch in this context. Part of behavioral finance is that people get worn out to the point of giving up at precisely the wrong time. On a smaller picture level, a distorted market is not a good thing ... but not knowing it was distorted would be worse.

If you are worried about some sort of meltdown because of all this, one answer is to pick some sort of objective trigger point to take defensive action. It would be better to do this now, while you are probably feeling pretty good. Also valid would be to allocate more to countries that had close to normal decades in their stock markets, have healthier economies and where desperate actions are not being taken. There are plenty to choose from.