The True Cause Of The 'Black Monday' Crash

The market crash that sent the Dow Jones Industrial Average plummeting by more than 1,000 points within minutes of the opening bell on August 24 has been partially blamed on a SunGard software problem that led to a large number of ETFs temporarily trading at heavy discounts to their net asset values.

However, according to Ben Hunt, chief risk officer at Salient Partners, the real cause of the crash was not a computer glitch, but rather a larger problem with the prevailing ETF trading mentality.

Allocation Versus Investing

In a new note, Hunt discussed the difference between investing and portfolio allocation.

Investing involves buying shares of a stock that represent fractional ownership of a money-generating company. ETFs by definition are funds, which means that they represent an allocation to a particular theme, rather than an actual asset that buyers want to own.

Like so many things in our modern world, the exchange traded nature of the ETF is a benefit for the few (Market Makers and The Sell Side) that has been sold falsely as a benefit for the many (Investors), Hunt wrote.

Related Link: Flow Data Reveals Where Money Has Gone The Week Of Black Monday

ETF Trading Benefits Wall Street

Hunt pointed out that it is in the best interest of market makers and sell-side firms to generate trading volume in ETFs, and the idea that a large portion of the August 24 ETF trading volume consisted of stop-loss orders being taken out shows how investors are looking at ETFs in the wrong way.

If youre an Investor with a capital I (as opposed to a Trader with a capital T), theres no good reason to put a stop-loss on an ETF or any other allocation instrument, Hunt argued. The point of an allocation is to expose a portfolio to a return stream with a particular set of qualities, and the price of the ETF has very little to do with that purpose.

The True Cause Of The Crash

Hunt believes that investors have succumbed to pressures from market makers and sell-side firms to speed up their trading habits and shorten their investing time horizons. This behavior will likely continue to manifest itself in the ETF markets in the form of wild price swings such as the ones witnessed on August 24.

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