Betterment's Market-Timing Issues; Not Sold On The Rally - Bezek's Daily Briefing

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Includes: DIA, FXB, FXE, JJC, QQQ, SPY, TLT, UVXY, VXX
by: Ian Bezek

Summary

After Monday's sharp fall, markets are starting to rebound.

I'm skeptical that the lows are in.

Brexit reveals a potential flaw for the robo-advisers.

Stocks continued their post-event slump on Monday. Global equities were again routed around the world; European shares, particularly the banks, had another day of panicked selling.

US stocks weren't immune from the selling. The Dow (NYSEARCA:DIA) dropped another 260 points on top of Friday's 600 point bloodbath. The S&P 500 (NYSEARCA:SPY) and Nasdaq (NASDAQ:QQQ) dropped by an even greater percent, both off around 2% on Monday.

This wasn't the sort of capitulation that has people in a state of full-blown panic. Volatility (NYSEARCA:VXX) (NYSEARCA:UVXY) was more or less flat on the session, there was no rush to add to insurance positions as Monday saw shares fall well below Friday's initial sell-off levels. Even with the S&P moving under 2,000 at one point, it didn't set off any sort of hysteria.

Perhaps not surprisingly, bulls have managed to build off the relatively calm finish to Monday's session (US stocks reclaimed 2,000, European banks pared losses) with a big rally to open Tuesday.

European stocks are up more than 3% in Tuesday's session at this hour. The euro (NYSEARCA:FXE) and British pound (NYSEARCA:FXB) have both put in their first meaningful bounces of the week. And US equities are up more than 1% at the open. Will the bounce stick? On that, I'm not optimistic.

The lack of a decisive panic at the bottom signifies that there are still a good deal of people hopeful for the "V" bounce and a quick recovery in stocks back to 2,100. The tone yesterday seemed very focused on "buy-the-dip" and not very much on taking caution against greater losses. Put otherwise, the market is still leaning toward the rebound scenario, and could still be caught painfully off-balance.

I was neutral on Friday as to whether we'd get a quick bounce or whether this would turn into a much steeper correction. On Monday, I turned significantly more bearish. This was two reasons: One, the Thursday overnight lows broke. That signified real selling interest, rather than just an overreaction in a thin market to an unexpected news event.

Bonds: Danger, Danger

And two, US bonds (NYSEARCA:TLT) made an utterly shocking burst higher. The 30-year treasury yield got obliterated, as it collapsed to 2.28% from 2.43% on the previous session. This was on top of Friday's gains. Add it up, and you've got a situation where bonds are pricing in a real disaster:

TLT Chart

TLT data by YCharts

Remember, bonds and equities generally move with negative correlation. The fact that bonds are hitting new all-time highs around the globe speaks to the potential for a much larger equity sell-off. Central bank intervention has allowed both bonds and stocks to rise in unison to a degree, but this isn't a permanent feature of the market.

Bonds are speaking clearly now, economic conditions continue to worsen. Look for far the long bond ETF TLT already is above where it reached in February.

Troublingly for Tuesday's rally, bonds are flat so far this morning, off by just 0.1%. If this really is "turnaround Tuesday" as people are calling it and stocks are about to take off, then there should be a great deal more profit-taking on bonds. The credit markets - usually deemed the smart money vis-a-vis the equity market - isn't buying this rally.

In the interest of adding a necessary caveat and supporting the alternative view, I should note that copper (NYSEARCA:JJC) has made a huge move higher this morning and now sits above the pre-Brexit level. Dr. Copper's indicative power lately has been a bit spotty, but it's still worth watching.

However, the broad call still is that this is a relief rally as part of a broader correction. Market lows normally don't come in such a gradual reversal as what we saw on Monday. And the bond market is reacting skeptically to the rally attempt so far today.

As far as levels go, the bulls are really shooting for a close above 2,050 later this week to take the more ominous bear cases off the table. If this is in fact the early innings of a steep correction, look for us to spend some time rattling around between 2,000 and 2,050 before another big push lower into the mid-1,900s.

Robo-Brokers: A Future Issue Lurks

Much of the financial industry has been watching the rise of the automated money managers with a mix of curiosity and trepidation. While they first seemed rather gimmicky, their continued expansion has led to real fears of job losses and increased competition.

Let's face it, many financial advisers don't have a great deal of wisdom to the markets, and essentially offer closet indexing with expensive fees that almost guarantees market underperformance. A robo-adviser can automate that and generally provide better returns. And a robo-adviser isn't generally going to sell you terrible products such as non-traded REITs, bad forms of life insurance, or huge load mutual funds. So I can see the appeal.

However, the drawbacks are also large and apparent. These systems will work for people who are willing to set-fire-and-forget. For people that can ignore the market noise (or simply don't follow finances), automatic contribution to a system that rebalances automatically, uses low-cost funds and uses some tax harvesting strategies is generally going to produce fairly good results.

But most investors aren't that coolly detached. Humans are still an emotional species after all, if we were drawn to robotic-like forms of investing naturally, there'd hardly be the sorts of manias and busts that make investing the world's most exciting intellectual game. Market manias occur preciously because the herd gets too excited at peaks and too depressed at the lows.

Investing is a very psychological venture, as proponents of "efficient markets" rediscovered to their peril in 2008. So on that note, it's worth considering the disclosure that Betterment shut off trading on its site on Friday morning supposedly to protect investors from higher bid-ask spreads caused by illiquid markets. The Wall Street Journal further reported that:

Betterment notified only its institutional advisers who use the platform. But no notice was sent to retail customers.

In a math-based rational world, this is probably a sound move on Betterment's part. Betterment concluded that investors would likely make decisions that they'd regret, and in a dash of paternalism, decided to make the proper choice for them. Institutional investors, being more sophisticated, could in theory be notified of what was occurring.

And it's true, in times of panic, people are prone to mindlessly selling stock. This tends to cause regret and then people feel compelled to buy back in later - at much higher prices - to "not miss out." It's a dark cycle.

But in making this choice for clients and not telling them, Betterment risks suffering a huge blow to its image during a future crash.

What happens on the one day when the Dow opens down 500 points and closes down 2,000? Another October 1987 crash is inevitable if markets keep operating long enough, it's just a matter of time. Someday, Betterment will shut down trading on customers, as it did Friday, and the market will crash from underneath them. Angry clients that tried to sell will sue or complain to high heaven and the business will be potentially ruined.

It's one thing to "nudge" people toward more rational and beneficial behavior. But shutting off trading and essentially locking customers into stocks at times of greatest uncertainty will almost certainly backfire in a massive way sooner or later. As one Betterment customer quoted by the Wall Street Journal noted: "Technically, it's your money, so you should be able to do whatever you want with it." The day when customers tried to sell and couldn't will be fraught with great danger for the robo-advisers.

Disclosure: I am/we are short UVXY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.