Reflections on What Happened 3 Years Ago and its Impact on ETF Trading
Today marks the third year anniversary of an “intraday flash crash” that had devastating consequences. Specifically, on August 24, 2015, approximately 1,278 stocks “gapped down” more than 5% at the opening, so the NYSE stopped trading on those stocks. However, ETFs continued to trade; but without knowing the underlying value of how much the 1,200+ stocks would reopen at, the ETF specialists at the time abruptly dropped their bids on ETFs approximately 35%. The apparent reason the ETF specialists only dropped their bids 35% was back in the May 6, 2010 intraday 5-minute flash crash when all trades that dropped 40% or more were reversed as if they never happened. The ETF specialists knew that they should not cross that 40% threshold, so they just “picked off” everybody 35% intraday instead. The next two charts show the intraday carnage:
The reason I showed the iShares Select Dividend ETF (DVY) being hit 34.95% intraday on August 24, 2015, is that I wanted to prove that a big, well-respected ETF, with high Morningstar Ratings as well as a nice dividend yield, was not immune to intraday Wall Street specialist shenanigans. Furthermore, a high dividend stock at the time, KKR, plunged 58.82%, apparently fuelled by intraday margin calls from investors that unwisely bought KKR and other high dividend stocks on margin.
The moral of the August 24, 2015 intraday flash crash is that Wall Street is only liquid at a deep discount and that stop loss orders cannot protect you from intraday ETF and stock price anomalies. The aftermath of the August 24, 2015 intraday flash crash triggered lots of interesting articles like the following:
Ironically, if you go to Morningstar and key in DVY, it shows that currently iShares Select Dividend ETF (DVY) is a well-respected 5-star ETF. Furthermore, DVY’s monthly Premium/Discount according to Morningstar is very low. In fact, in August 2015, the average discount was only -0.01%. So this implies that despite the 34.95% intraday drop on August 24, 2015, this price drop must have been an anomaly, since the average discount was only -0.01% during August 2015.
As a quantitative analyst, the only way I can duplicate Morningstar’s monthly Premium/Discount calculations is to calculate volatility based on closing day prices, which effectively mask the 34.95% intraday drop on August 24, 2015. However, when I do “full range” volatility based on all trades of DVY during August 2015, the 34.95% intraday discount reappears. In other words, based on my calculations, Morningstar is not doing its math correctly, since it appears that its monthly Premium/Discount calculations are based on an end of the day closing price, versus all intraday ETF trades during the day.
When you look at only ETF trades at the end of the day, it tends to show a very pretty picture of many ETFs. As an example, our friends at Bespoke recently published a fascinating research article (below) called “Fear the Day.” Specifically, Bespoke’s research pointed out that if you bought the biggest and most liquid ETF, namely SPY, at the opening and sold it at the close every day since January 1993, between January 1993 to January 2018 you would lose -11.9%. On the other hand, if you bought SPY at the close and covered it at the opening every day since January 1993, between January 1993 to January 2018 you would make 565%! This amazing 576.9% return differential is due to the fact that Bespoke’s research proved that more than 100% of SPY’s gains since 1993 happen after market hours.
So apparently, the moral of the story is that if you want to be a successful ETF investor you have to stop trading ETFs during the day! Well not exactly. If you can successfully buy or sell an ETF at or near its net asset value or what Morningstar calls Intraday Indicative Value, then go ahead and trade during market hours. However, as too many ETF managers have learned, moving big blocks of ETFs during market hours can be problematic, which is why my management company has stopped trading via many large model management platforms that insist on doing the ETF trading themselves, which raises the conflict that the ETF specialists can pick off ETF managers as the following article explained for one unfortunate ETF manager:
At my management company, we are currently proud to be the #1 ETF manager according to Morningstar Advisor out of the 469 GIPS certified managers in the past 3 & 5-years (see next page). However, if we signed up for many popular model management programs that financial advisors utilize, we would not be always be able to effectively execute our ETF trades, so you will not see Navellier & Associates’ managed ETF portfolios in many of the big model management programs, since we do not want to lose control of ETF trading. In my opinion, the best model management program is led by Craig Love at Fulcrum EQ in Dallas, because his platform allows big “step out” trades with the ETF firms themselves. Essentially, when we have to move big blocks of ETFs, we have the option of calling the respective ETF firm and they help us move big blocks of ETFs with minimal premiums/discounts.
So the moral of this story is that much of our managed ETF success comes from (1) waiting to trade ETFs during orderly markets with minimal premiums/discounts relative to net asset value, (2) avoiding poor trading platforms that prohibit “step out trading” to more effectively move big ETF blocks, and (3) naturally buying great smart Beta ETFs, especially the AlphaDEX ETFs from First Trust. I should also add that so far in 2018, our ETF turnover has been low, since we remain in a very selective market that is favoring a few key sectors and more domestic small-to-mid capitalization stocks. ETFs that emphasize fundamentally superior stocks and are more equally weighted, like the First Trust AlphaDEX ETFs, remain crucial for our success in the current market environment.
CEO/Chief Investment Officer
Disclosure: This information is general and does not take into account your individual circumstances, financial situation, or needs, and is not presented as a personalized recommendation to you. This is for informational purposes only and should not be taken as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in your investment making decisions. Individual strategies discussed may not be suitable for you, and it should not be assumed they were or will be profitable. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. All investing is subject to risk, including the loss of your principal.