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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.
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
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.