What Drove the Markets Higher Is Now Knocking Them Down

Shah Gilani

Good corporate fundamentals (meaning rising revenues), margins, and profits drove big-cap technology stocks higher. Those factors drove their respective indexes higher, which attracted millions of passive investors into indexed mutual funds and ETF products.

Now, the virtuous cycle that caused markets to spiral upwards could be morphing into a negative feedback loop. But markets in the U.S. aren't going down because fundamentals are deteriorating.

They're going down because market-moving tech darlings stalled out – then rolled over.

I have good news, and I have bad news. The bad news is the selling's probably not over and could get worse.

The good news is, if we fall far enough and fast enough, this sell-off could be a generational buying opportunity.

Here's what's really going on, why this sell-off (if it's big enough) will be the time to go all in, and what you can do to shield yourself from any market disaster…

What Fueled the Negative Feedback Loop

What started with profit-taking in big-cap tech stocks, when an increasing number of analysts and talking heads warned of tariff wars and lofty markets, led to short sellers piling on to try and knock stocks down.

This time around, sellers weren't met by billions of incoming dollars from passive investors.

Crucial: This “Misunderstood” Industry Could Singlehandedly Double or Triple Your Profits

Net inflows into mutual funds and ETFs were down 46% in the third quarter, according to Morningstar. Through September, $281.7 billion flowed into the market, down from $517.2 billion over the same span a year ago.

Actively managed funds saw $42.9 billion in outflows in the third quarter, the highest amount exiting since the fourth quarter of 2016. Meanwhile, passive investors ponied up 35% less in the third quarter than they had a year ago.

The net amount of money flowing into the market, chasing the tech darling leadership stocks and the rest of the stocks under their cover, suddenly wasn't enough to absorb selling when profit-taking increased as short sellers tried to knock the big names through support levels they had all quickly bumped against.

When those support levels broke last week, profit-taking ratcheted up, shorts piled on, and, more importantly, so-called passive investors actively started selling.

Passive investors turning into active sellers became the negative feedback loop's fuel.

The passive investing trend, the latest iteration of old-school buy-and-hold, is relatively new. It started gathering momentum a few years after the financial crisis, when there weren't many stock pickers hitting home runs, but the indexes made new highs.

But the reality of the trend's short history is passive investing's new adherents haven't ever been tested. They've never seen a sell-off of more than a few weeks.

They've been passive because they've had no reason to become "active."

But there are plenty of reasons to expect them to hit the brakes, throw their accounts into reverse, and actively sell when things get bad.

How the Negative Feedback Loop Works

Join the conversation. Click here to jump to comments…

Shah Gilani

About the Author

Browse Shah's articles | View Shah's research services

Shah Gilani is the Event Trading Specialist for Money Map Press. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains.Shah is also the proud founding editor of The Money Zone, where after eight years of development and 11 years of backtesting he has found the edge over stocks, giving his members the opportunity to rake in potential double, triple, or even quadruple-digit profits weekly with just a few quick steps. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

… Read full bio