When it comes to explaining market sell-offs, look for the simplest explanation

Published Thu, Dec 21 20238:23 AM EST

Occam's Razor, named after 14th-century philosopher William of Ockham, states in its modern formulation, "The simplest explanation is usually the best one." It means that when you are presented with various explanations for the same event, you should prefer the one with the fewest assumptions. The simplest explanation for Wednesday's sell-off was that the market was dramatically overvalued and due for a pullback. The S & P 500 had risen 3% in less than two weeks and every technician in America was screaming it was stupidly overvalued and predicted an imminent pullback. When it began to weaken late-day traders who were sitting on big gains sensibly began to take profits, which cascaded. That is the simplest explanation. Of course, no one likes simple explanations anymore, so some people trotted out the usual suspect: options trading. Traders were shocked — shocked! — to discover that other traders, sensibly noting how stupidly overbought the market had become, had bought puts (bearish) just below the market as protection. When these puts went in the money (they became profitable), it created more selling, partly from dealers who had sold these puts in the first place and now had to hedge themselves. Since a very large percentage of options trading is in zero day to expiration options (0DTE) in the S & P 500, which expire at the end of every day, everyone pointed to that as the cause. .SPX 3M mountain S & P 500, 3 months Once again, look for the simplest explanation. Here, investors are confusing cause and effect. The cause of the sell-off was that the market was stupidly overbought and subject to a sudden bout of selling. The effect was that out of the money put options suddenly went in the money. That there might have been a large amount of volume in these near out of the money options would make sense, given how overbought the market had become. The bigger question is, how much more juice is there left in the soft landing play? Is there enough juice for the Santa Claus rally, which starts Friday? There might be. In the category of "there's an ETF for that," there are many different ways traders have been trying to play the soft landing story. One of the many back-door ways I have seen in the past few weeks is using ETFs to play global shipping, working on the assumption that the soft landing would benefit anyone shipping stuff. It's a reasonable assumption, but it's very tricky and it may not be worth anyone's time. Still, a lot of people are trying. Want to follow dry bulk shipping rates? Look at the Breakwave Dry Bulk Shipping ETF (BDRY). It tracks the nearest calendar quarter of dry bulk freight futures contracts. These are contracts on shipping costs for commodities such as iron ore, coal, and grain. The contract prices can depend on the size of the ship carrying it: large (Capesize), medium (Panamax) and smaller (Supramax). BDRY is essentially a play on global shipping, which is itself a play on the state of the global economy. It can be ridiculously volatile — it was up over 300% in 2021 on the global supply chain crisis, then fell apart in 2022 and again in much of 2023, mostly blamed on China's tepid post-COVID recovery. And it is doing it again. Since the start of November, it is up 100% as plummeting interest rates has ignited a belief that a recession is not imminent in the U.S. There is a similar tool to track global shipping you may have heard of before: the Baltic Dry Index, which tracks the cost of transporting various raw materials by sea, including iron ore, coal, grain, steel products, sugars, and cement. It hit an 18-month high in the first week of December, a sign of strong global demand, but has since come off that high. Not surprisingly, there is a correlation between BDRY and the Baltic Dry Index, but only a loose one. The correlation is only directional--when one is going up, the other is usually as well, but the returns are very different. This year, for example, the Baltic Dry Index is up 46%, but BDRY is up 9%. It may be that BDRY reflects the cost of additional factors like the cost of fuel, or port tariffs. There's an ETF for global shipping companies If you'd rather play global shipping companies directly, there's an ETF for that as well. The SonicShares Global Shipping ETF (BOAT) is a modified market cap weighted ETF that contains all the big global shipping companies: Kawasaki Kisen Kaisha, Mitsui, Euronav, Matson, AP Moller, Hapag-Lloyd, Maersk, COSCO Shipping, etc. It has rallied 10% since November. The problem with investing in shipping companies as a way to play a global economic expansion is the same problem as investing in gold companies as a way to play higher gold prices: there is a relationship (higher shipping prices should help the stock of shipping companies), but there are a lot of other factors that could influence shipping companies independent of commodity prices, like fuel costs, maintenance, and management issues. What does all this mean? It means that using these back-door ETFs to play a global recovery can be very tricky. This year, for example, the Baltic Dry Index has been extremely volatile, down at one point over 60% on the year in February, then doubled between November and early December. DBRY has also been on a wild ride. Here's my two cents: playing an economic recovery through commodity futures, bulk shipping futures, and even stocks of shipping companies is a second-order play. All sorts of other issues can affect those investments independent of a pure recovery. This strikes me as way too much work. Better to stay in the broad market and own the S & P 500. If you have opinions on investing outside the U.S., there's tons of country specific and sector specific ETFs to choose from. I recently did a very interesting ETF Edge show on investing in India in 2024, which you can see here .