One of my pet peeves is when market pundits (who really should know better) use questionable stats to make some sort of (supposedly) ominous point. I won’t bother mentioning which site the latest example came from, but you can probably guess pretty easily. The headline was “S&P ETF Outflows Soar To Biggest Since 2008.” Sounds scary, right?
In the post the author shows a graph of the price of the S&P 500 ETF with the rate of change in the number of units outstanding in the sub-graph at the bottom. In big red marker they have highlighted OUTFLOWS for the area where the number of units outstanding has declined. I have recreated the graph in my Bloomberg, but I have also included the total amount of units outstanding so we can get a better sense about what is going on.
There has indeed recently been a big redemption of SPY ETF outstanding. But what does that really mean?
In my past life I was the index derivative trader for Canada’s largest bank. Although our American friends do everything bigger and more brashly than their Northern neighbours, we still had a decent size book even by US standards.
Although my job was mostly proprietary trading, I ended up talking directly to a few of the biggest index clients. During this period one of the Canadian provinces’ pension plans, which had been invested solely in fixed income, was mandated with shifting a large portion of their portfolio into equities. It was a massive amount of equities that they had to buy.
Not being one of those fancy smooth talking salesmen, I went for the more direct humble approach. I told the portfolio manager that he had so much stock to buy that when he wandered into the market, he was going to send stocks to the moon. If he tried to buy it in an up market he was going to cause a stampede. Not only that, but everyone would see him coming, and push it even higher on him.
I told him that the only way he could buy the amount of stock he needed, was to buy in a down market. He needed to provide liquidity instead of demanding liquidity. It would be scary, but he needed to be the bid that everyone was hitting on the way down.
My pitch seemed to resonate with the PM. All the other dealers were trying to show him massive stock offerings way up higher. They all figured him for a sucker from some small Canadian province. My plan made sense and seemed more far more prudent.
So everyday the PM would give me an order to buy a block of TIPs (which were the Canadian SPY equivalent and in fact, created before SPYs) down a certain percentage. Once filled, there would be another even bigger order right below. A lot of days we did no business. But when the market would fall out of bed – we would catch it. On the down days we would buy gobs of stock. When everyone was puking, we were there filling up our bucket. During the next six months we moved that Province’s bond portfolio into equities with few realizing it.
The PM later told me that he was just waiting for other brokers to figure it out. We were doing 90% + of his business and he knew that he couldn’t keep giving us that much. But everyone else was too busy trying to rip him off by showing him pieces up above. No one else ever did figure it out.
What does this have to do with the recent headline about the biggest decline in SPY units outstanding?
During this period my client would buy TIPs and then when he reached a certain size, he would sell them back to us in exchange for the underlying securities. He would use the TIPs as an easy way to gain exposure to the index, but eventually he would switch them into the actual stocks.
We had TIPs redemptions that were absolutely massive. But that did not mean that someone was actually selling the index. It meant nothing more than a reshuffling of a different way to hold the index constituents.
Back to our SPY redemption headline from yesterday. If we expand the chart above a little further back in time, you will notice an interesting thing happened during the 2008 credit crash.
As the index plummeted, the amount of units outstanding of SPY ETF actually increased. Portfolio managers were most likely using the SPY as a way to gain exposure to the index without having to pick individual stocks. The amount of units outstanding doubled during 2008! Yet stocks kept going lower and lower.
The actual day to day creation or destruction of SPY ETF units means absolutely nothing. Since most modern day portfolio managers are like my old client in their ability to switch between the ETF product and the underlying, it is too difficult to guess their real exposure.
The SPYs are much different than some of the speciality ETFs like BKLN, where the portfolio managers are probably not prepared to take delivery of the underlying loans that make up the ETF. In that case, monitoring the flows is useful.
But in the case of the SPYs, there are too many different possibilities to read anything into the recent ETF redemption.
Don’t get me wrong, I am bearish too. I just want to be bearish for the right reasons – not because of some scare mongering headline that means absolutely nothing.
No bid in USDJPY
Yesterday we hit an air pocket in Yen. Out of nowhere the Japanese Yen spiked 60 pips. For no reason at all.
There was no rumour of some geo-political event. There was no economic news. There was no correlated asset pressuring the Yen higher.
There was some talk about the order being a fat finger. I don’t buy that. If it was a fat finger, then the trader usually has to unwind the error, and the price quickly heads back to the level before the order.
No – someone needed to buy 3 yards of Yen, and they needed it right away.
My guess is that there are still a lot of hedge funds using the Yen as a funding currency.
Don’t forget the Wall Street axiom:
“Liquidity is a coward; when you need her most she runs away and hides!”
I think this sort of vacuum move is a precursor of moves to come. There are a slew of assets that are precariously balanced. Once they start to unwind, there are going to be more moves out of the blue like this one. This sort of unexplained unwind is going to increase in the future. The fun has just begun.