Over the course of this year I saw something in markets that early on I couldn't explain. I suspected that there was something different with market structure that was dangerous but I didn't know exactly what. I now mostly know what is going on.

Starting back in the 2nd quarter I started using a phrase, the "networked traders" to describe what was happening with certain stocks. It started in energy as companies with billions in assets saw their share prices pushed down as if oil and gas would stay cheap forever and that they were on the verge of bankruptcy. While some energy companies are on the verge of bankruptcy, most aren't. 

By the 3rd quarter the overreactions started to move into other sectors with other stocks. We have seen stock prices in virtually any growth company with debt get decimated. At the same time, we have seen over 90% of all market gains concentrated into the biggest 50 stocks on the stock market - clearly not a healthy sign.

What is driving the over reactions is a change in who controls the flow of money into and out of stocks. In the past, when a stock would get beaten down unnecessarily, there would be bargain hunters who come into buy. Today, the bargain hunters are sitting on their wallets as they are, in my opinion rightly, afraid of the downward momentum in stocks that are falling in price, and can't justify buying the handful of big market cap companies that are rising on ratios that make no historic sense.

Those who are controlling the market are usually referred to as "momentum traders." It is unusual that this would happen during any period other than a crash or euphoric spike upward in markets. Today's market is very reminiscent of 1999 when most stocks fell in price, but a narrow group of large companies and technology stocks rose by multiples. 

The momentum traders have a few powerful weapons on their side right now. The most important is the internet. Not only can these traders maintain a loose affiliation via chat rooms and social media, but they are generally receiving their information from the same places. This leads to a herd mentality like none I've ever seen in 20 years. 

A complicating factor, which I brought up in a forum post titled "Jesse Liveremore We Ain't" is that the internet is allowing a lot of bad information to be distributed. This bad information leads to the creation of nervousness among investors that turns into fear when their shares start to fall in price. It also leads to remorse as they see a handful of the big stocks go up in price. The result is selling near the bottoms on their investments only to buy near the tops on others. While clearly that has always been a problem for emotional investors with weak underlying knowledge of their investments, it is much more pronounced now.

It is important to know that the bad information comes in two flavors. The first is the typical people not being particularly good at their jobs of analysis. The second is more nefarious though. There is a group of investment research firms that will publish an opinion for a price that supports the investment strategy of whoever is paying them.

In the past if you wanted to use a research piece to support your investment thesis, you would find it and point it out. Today, you pay to have it written exactly how you want it written. Then you get that "independent" piece out in the media as much as possible, generally via the internet. Unfortunately, now the television media is starting to give these pieces and their authors air time as a stock price is moving in their direction, rewarding them for being manipulative and adding to the effect. I wonder if in a few years the press will be doing stories about how wrong 80% of these independent research firms were?

The power of the momentum traders, largely fueled by bad information and weak market participation by many other traditional investors, is likely to persist until the next round of Quantitative Easing by the Federal Reserve. I don't know when the next QE is going to happen, but I am 100% certain it will happen again as central bankers are convinced that QE fights deflationary forces that otherwise would have us in a generation long depression (I agree with them).

On MarketWatch, I suggested that the Fed do QE, in conjunction with raising rates, to reduce liquidity issues. On my Twitter feed I posed a challenge to pick the next time the Fed creates extra money. The date I picked was the April Fed meeting, although I hope they do in fact do it in December along with a rate hike which will acknowledge the new normal of permanent slow growth.

I believe that investors should continue to hold 25-50% cash, or an intermediate term U.S. Treasury fund, in order to keep some powder safe. Make sure to make a list though of investments to buy as prices become too good to resist - there's a few lists here for subscribers that I am adding to this month.

There is no depression coming. The central banks won't allow it and eventually the governments of the world will rebuild the infrastructure of the planet that they have been deferring maintenance on for 3 decades. You will want to take part in what benefits from money printing and infrastructure building, as well as, eventually, more consumers in emerging markets.

For those at the 25-50% cash level already, there is little point selling stocks that are already down, presuming you are not overextended on some stocks. Vanguard has proven that buy and hold puts the calendar on your side. Use the calendar. Eventually, you'll wake up and most of your losers will be winners. The moves upward, when they happen, will be big and fast as the combination of fundamentals, stimulus and a change in momentum take hold.

Kirk